So far we've looked at the basics of subcontracting and allocation of credit risk, how a mechanic's lien changes things by reallocating credit risk, and how a contractor, subcontractor, supplier, or worker goes about acquiring a mechanic's lien. Now let's assume you are a subcontractor with a claim against the general contractor, or GC, for $15,000. The GC has withheld that amount from your fees, accusing you of not finishing your work on schedule. The general contractor says it incurred $15,000 in additional labor charges because its workers had to wait around with nothing else to do until your work was completed. You blame the general contractor for the delay and additional expense, and you have recorded a sworn statement and notice of intention to hold a mechanic's lien in the amount of $15,000. A copy of it has been sent to the owner.
Now what happens?
At this point, there are several possibilities.
- What you hope will happen is that either the owner or the GC will pay you - you hope it will be the entire amount but more likely it will be a negotiated compromise amount - in exchange for your signed release, which will then be filed with the county recorder. If the owner pays you, it will probably turn into a dispute between the GC and the owner, but you will not be involved (except as a witness).
- If the owner believes there is a flaw in the lien, for example that it was recorded too late, the owner can challenge the lien in court, asking the court to remove it. If the owner is successful, it does not mean that you lose your claim. You will still have a breach of contract claim against the GC, but, if you win that case, your ability to collect will turn on the ability of the GC to pay. (Remember that earlier discussion of credit risk? The lien reallocates the GC's credit risk to the owner because the owner's property serves as collateral to secure your claim. Without the lien, the GC's credit risk falls back on you.) By the way, recording a lien that is invalid can make you liable to the owner for a tort known as slander of title.
- The owner can post a bond to serve as substitute collateral and ask the court to order that the lien be released. That removes the owner from the middle of your dispute with the GC. If you sue the GC for breach of contract and win, and if the GC does not pay you the amount of the judgment, you can collect from the surety who underwrote the bond. (In essence, the GC's credit risk is again reallocated to the surety who charges a fee to assume that risk.) This process is often called "bonding off" a lien.
- The owner and GC can wait to see if you sue to enforce the lien. If you do not sue within one year, the lien expires. If that happens, you will still have your claim against the GC because the statute of limitations on your breach of contract claim is either six or ten years. (See our earlier blog for a discussion of the uncertainty in the exact amount of time you have to sue the GC.)
- The owner can send you a letterdemanding that you sue to enforce the lien within 30 days. If you do not, you lose the lien. It's sort of a put-up-or-shut-up provision in the mechanic's lien statute that gives the owner a way to speed things along.
- You can sue to foreclose on the lien. However, to do that successfully, you will have to prove that the GC actually owes you the $15,000, which means you will have to litigate your breach of contract claim against the GC. Although there are a few different procedural paths to get there, the lawsuit will involve you, the GC, and the owner. If you lose on the breach of contract claim against the GC, the court will order the lien to be removed. If you win on the breach of contract claim against the GC, and the GC pays you the amount of the judgment, the lien will be removed. If the GC does not pay you the amount of the judgment, the owner can pay you, and the lien will be removed. If you win against the GC and neither the GC nor the owner pays you, you can force a sale of the owner's property, with the amount of the judgment being paid to you out of the proceeds of the sale and the balance paid to the owner.
As we've discussed, all the lien really does is to reallocate to the owner the risk that the GC will not pay you the amount you are properly owed. In most cases, if you win your breach of contract case against the GC, the GC will pay the judgment and the lien will be removed without the need for you to foreclose.
So what good does a mechanic's lien do? Really?
In the case of a mechanic's lien filed by a general contractor, the lien provides the GC with collateral to secure its claim against the owner. That can be very important if the owner goes into bankruptcy because the GC will be a secured creditor rather than an unsecured creditor. Of course, in most cases, if the GC wins its claim against the owner, the owner will pay and the lien will be removed. In addtion, sometimes it gives the owner an additional incentive to settle a claim by the GC because selling the property will be more difficult while the lien is in place. (Of course, if the owner really wants to sell the property, the owner can bond off the lien, albeit at the expense of having to pay for the bond.)
From a legal perspective, things aren't much different for a lien recorded by a subcontractor, but as a practical matter, the ability to record a lien gives the subcontractor more leverage in negotiating a resolution to a dispute. The lien will bring the owner into the discussion, and that may provide the GC (or higher tier subcontractor, as applicable) with additional incentive to settle your claim.