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Chapter 3:

Your Options Under a Lien

 

I want to sell or refinance my property. What options are available to me if there is a mechanic’s lien on my property?

You may have contracted to sell your property. The closing date is approaching. There is a problem with the work performed by a contractor you hired to get the property into shape for the sale. You and the contractor are now in a dispute about the quality of the work and it is clear that this dispute will not be resolved by the closing date. What can you do?

What is the Role of a Title Insurance Company?

A title insurance company is hired to provide the closing and settlement services and to issue the report on title (commitment) and the policies of title insurance to the buyer and the buyer’s lender. This is usually part of the contract terms.

The title insurance policy essentially insures that the buyer will be the owner of the property and that there are no defects, liens or encumbrances which can affect the ownership. Any existing liens are cleared as part of the closing process by the seller paying these liens from the sale proceeds. A mechanic’s lien will be one of the liens to be cleared at closing and, almost certainly, the buyer and the title insurance company will require payment to the contractor before allowing the closing to take place.

Unless you are willing to pay the contractor, then you should request the title insurance company to withhold an agreed amount from your sale proceeds and to retain that amount in its escrow account. This is commonly called “escrowing” or “bonding” over the lien. In this context, both terms have the same meaning, but “bonding” over the lien can also have a very different meaning, as explained later.

How is the Escrow Done?

The title insurance company will require you to enter into an agreement with them. This agreement usually sets out the terms of the escrow (such as the duration of the escrow, disbursement of the escrow on completion) and will include an indemnity from you in favor of the title insurance company essentially holding them harmless and agreeing to reimburse then for any loss they may incur as a result of the enforcement of the mechanic’s lien.

How is the Escrow Amount Determined?

The amount of the escrow probably will be based on 150% of the face amount of the lien. This percentage is taken from the amount required to bond over a lien under the mechanic’s lien statute. Some title insurance companies may require more than this percentage. The term of the escrow will be based on the same statutory time limits, discussed above.

At the end of the applicable time period, the title insurance company will return the amount escrowed, unless the contractor has commenced a foreclosure action.

There is a serious pitfall in using an escrow. If you cannot resolve the dispute, then the contractor’s most powerful weapon is to start the foreclosure of the lien. This court based action immediately puts the ownership of the property at risk and will force the seller, the buyer, and the title insurance company to respond.

The escrow agreement probably will authorize the title insurance company to use the escrowed funds to pay the contractor to prevent the threat of foreclosure (which is its duty anyway under the terms of the title insurance policies). This is contrary to your intention to hold the escrow to buy time to resolve the dispute post closing.

Finally, the buyer, and potentially the buyer’s lender, should agree to this arrangement. In many cases, they will refuse to allow the escrow and demand payment of the mechanic’s lien.

Substitution of Bond (“Bonding Over”)

This is not the same procedure as “escrowing” over the lien described above. This is a procedure authorized by the mechanic’s lien statute.

A court action must be commenced by the owner to apply to the court for the acceptance of a bond in substitution for the lien over the property. The court, if satisfied that the bond provides the required collateral, will issue an order directing that the mechanic’s lien claimant can obtain satisfaction of its lien from the issuer of the bond. At the same time the court will order a release of the mechanic’s lien from the property.

Often the contractor has already commenced a court action to foreclose a mechanic’s lien, in which case the owner can file the motion for substitution of bond in the same case.

The owner must deposit cash in the amount of 150% of the face amount of the lien, or, alternatively, obtain a bond for this amount. The bond will be issued by a reputable insurer who will require the owner to provide some type of collateral security to the insurer, and the payment of a fee for issuing the bond.

If you have established an escrow with a title insurance company, then you may be able to request the company to pay the escrowed funds into the court registry in exchange for the court ordered release of the mechanic’s lien.

What About a Tenant’s Improvements?

Be careful when allowing a tenant to construct improvements on your property. Although the tenant will enter into the contract with the contractor, the owner is deemed to have been party to that work and the right to a mechanic’s lien will attach to the property, even though the work is for the tenant.

The effect of this stringent rule can be avoided if the owner gives notice either (1) to the contractors, or (2) by posting it in a conspicuous place on the land and buildings. This notice must be given within five days after the owner has knowledge of the tenant’s proposed improvements.

Once the notice has been given, the owner’s property will not be subject to a mechanic’s lien arising out of the tenant improvements.

You may have seen these notices frequently posted in the entrances and lobbies of commercial buildings.

If I Don’t Pay the Contractor, What Will Happen to My Property?

The answer to this question goes to the heart of the special status given to mechanics’ liens.

If you fail to pay the contractor, the contractor will exercise its rights under the mechanic’s lien law to file a statement of lien (after giving you the statutory notice and in accordance with the applicable time periods) and then commence an action to foreclose the lien.

This immediately places the owner in a defensive position, forcing the owner to respond to the complaint and to go through the court process. The owner, of course, can defend the action, but this is time consuming and costly, involving depositions, discovery, and eventually a trial.

A feature of the mechanic’s lien statute is that if a contractor commences the foreclosure action, all other contractors are brought into the same action, resulting in multiple parties, and greatly increasing the size, scope, and cost, of the action.

You are strongly advised to consult your attorney about this and not to go it alone.

Are There Contractors Who Do Not Have the Benefit of the Mechanic’s Lien Laws?

Unless the contractor performs the specific types of work that are specified in the statute, the contractor cannot claim a mechanic’s lien. Examples include the periodic maintenance contracts for garden and lawn mowing services, house cleaning services, janitorial services. However, keep in mind that if, for example, a landscape company installs a new irrigation system, then this company will be entitled to a mechanic’s lien for that improvement, although its general maintenance work will not be so entitled.