Participation Owners

Encorcing a Mechanics' Lien for Materials Against
a Non-Contracting Party

During the past several years, the construction industry has enjoyed an unprecedented level of success ranging from new homes to business developments, including leasehold improvements on real property. The industry's success in large part is built on the extension of credit from "materialmen," or suppliers of material goods. The industry depends on credit because construction contracts seldom provide advance payment to contractors, but instead rely on scheduled or quarterly payments. Accordingly, a contractor usually does not have the capital to finance the improvements without the availability of credit.

As with any credit extension, there is a risk of nonpayment. The mechanic's lien has become the mechanism to assist in minimizing that risk by providing security for the underlying debt in the land and structure subject to the improvements.

However, a mechanics' lien may be unenforceable against the property owner if the materials are supplied in connection with a contract enter into with the lessee to make improvements on the land. If the lessee defaults or files bankruptcy, then the material supplier may be without a remedy, while the property owner receives a benefit without cost.

Mechanics' Liens and Material Goods

The mechanic's lien is a statutory, or in some states, a constitutional remedy and creation of state law. Although each state has its own version and requirements to enforce mechanics' liens, these statutes share common attributes. A claim for a mechanics' lien is an action in property to recover for materials furnished, not a personal action in contract for repair or improvement (e.g., breach of contract or quantum meruit, respectively).

In some states, enforcement of mechanics' liens is accomplished by foreclosure proceedings. Mechanics' lien statutes only protect certain classes of professionals or tradesman that contract with the owner or leaseholder for improvement of the property. The supplier of materials should appreciate the differences posed by contracting with the property owner directly or through the leaseholder individually.

It is important to consult the specific state law to determine the treatment of materials. State law dictates whether materials will qualify to enforce a lien. Generally, materials qualify for a mechanic's lien if incorporated into an improvement and with accompanying knowledge of their intended use on a specific site. Alternatively, some states specifically designate certain materials for qualification. The state laws on whether non-incorporated materials (e.g., rental equipment, utilities, maintenance, etc.) vary from state to state.

Improvements to Leasehold Estates

A payment issue may arise when materials are supplied for a project involving improvements to a leasehold estate. Generally, the leaseholder, not the property owner, contracts to construct the improvements. However, the law of fixtures regards a building as becoming a part of the land after it is constructed, belonging to the property owner.

If the materials are furnished to a leaseholder for improvements, then the property owner may not be held liable for the payment, despite the owner's benefit of improved land. Accordingly, if the leaseholder defaults or claims bankruptcy, a materials' lien may have little or no effect.

Where Owner May Not Be Liable For Improvements

The states have taken two approaches to balance the unfairness of subjecting a noncontracting owner to a lien and the possibility of unjust enrichment. Under the first approach, a non-contracting owner is subject to the mechanics' lien if there is notice of the improvements, unless the non-contracting owner objects to the improvements and/or notifies the parties of its nonresponsibility.

Generally, the statement of nonresponsibility is in writing and filed with the appropriate state authority within ten days from the date of notice that improvements are being made to the property. The alternative theory is that a non-contracting owner is only bound if written assent subjects his interest to a lien. If the non-contracting owner has taken these steps to avoid liability, then the material supplier may have little or no recourse for payment except through the leaseholder. The material supplier may have to absorb a total loss, if the leaseholder defaults or files bankruptcy. The only recourse may be to pursue the non-contracting owner under an exception.

Participating Owners Liable For Improvements Despite Notice of Nonresponsibility

The material suppliers' only recourse may to claim that the non-contracting owner is a "participating owner" of the improvement project. Under the participating owner doctrine, suppliers have been increasingly successful in imposing mechanics' liens on a non-contracting owner's property interest.

To obtain this result, suppliers have used the non-contracting parties' involvement and control to obtain payment for the materials furnished. A mechanics' lien will attach to the non-contracting owner's interest in the leased property if substantial leasehold improvements are a condition to the lease, or the non-contracting party has played an active and substantial role in the improvements.

In determining whether a non-contracting owner may be held liable for a mechanic's lien as a participating owner, notwithstanding the posting of a notice of nonresponsibility, courts have considered the following factors: first, where substantial improvements are a condition to the lease, and but for those improvements, would the parties have consummated the lease; second, did the non-contracting owner retain substantial control over the improvements, including approval of plans, specification, and reversion of improvements upon termination; and third, the courts consider the expertise of the non-contracting owner. In consideration of these factors, the noncontracting owner must participate more than providing cash incentives to complete improvements.

The End Game: Getting Paid With Priority

The mechanic's lien is a useful tool for getting paid. If the materials are supplied to improve a leasehold estate, then monitor the actions of the property owner carefully. If the leaseholder defaults, then the material supplier may want to file a mechanics' lien against the property and pursue the property owner.

Additionally, mechanics' liens receive priority over other creditors, including judgment and mortgage liens. Depending on the state, mechanics' liens can receive significant favor and may subordinate any other lien, mortgage, deed of trust, or other encumbrance. Furthermore, if a priority lienholder failed to record or give notice, the mechanic's lien will receive priority.

Blakeley & Blakeley LLP Reprinted by permission from Trade Vendor Quarterly