In the late 1980’s, the Colorado building community suffered through a bust. In many situations, contractors allowed their account receivables to mount in mistaken reliance upon the perceived strength of their mechanic’s lien rights. Though mechanic’s liens can be tremendously powerful weapons in the collection battle, they are not all powerful. A sound account receivable policy should be based upon an awareness of some of the pitfalls of mechanic’s liens.
Residential Specific Problems
Pursuing mechanic’s liens against residential properties has always been more difficult than pursuing liens against other properties. (See section (c) below.) However, in 1987, the Colorado legislature made it especially difficult for suppliers and sub-contractors to pursue lien claims against residential property. Mechanic’s liens cannot attach to a property if the owner has fully paid his general contractor in the following situations: (a) the property is an existing single-family dwelling unit (e.g., when a homeowner finishes his basement); (b) the property is a residence constructed by the owner or under a contract entered into by the owner prior to its occupancy as his primary residence (e.g., a custom home); or (c) the property is a single-family, owner-occupied dwelling unit, including a residence constructed and sold for occupancy as a primary residence (e.g., an owner occupied tract house.)
If the owner pays its general contractor, and the general contractor does not pay its subs or suppliers, those subs and suppliers have no lien rights. On residential properties, it is especially important to work with reputable general contractors.
Mechanic’s Liens Do Not Last Forever
In general, mechanic’s liens remain effective against the property for only six months after substantial completion of the improvements to be constructed upon it. In most situations, if the foreclosure of the lien (or some other mechanic’s lien on the property) is not commenced within the six month period, the lien disappears. If a project has been abandoned, substantial completion is deemed to have occurred three months after abandonment. The statute provides that no lien shall be effective against property for more than one year after its recording, unless, within thirty days after the anniversary date, an affidavit of non-completion is recorded by the lien claimant against the property. After recording your lien, do not sit and wait to be paid. Be mindful of the impermanence of your lien.
There is little point in having your mechanic’s lien attach to a $300,000 property which is subject to a $350,000 deed of trust having priority over your lien. Mechanic’s liens are an exception to the general notion that priority amongst lien claimants is determined by “first in time, first in right.” The priority of mechanic’s liens “relate back” to the point in time of the commencement of the first work under a contract between the owner and the first contractor. If the contract is not in writing, the priority of the mechanic’s liens relate back to the commencement of the first work improving the value of the property.
Because it is not unusual for some building trades (e.g., architects) to provide services before an owner obtains its construction loan, it is common to see mechanic’s liens take priority over a construction loan. However, lien priority should not be assumed and should not lull a lien claimant into a false sense of security. As your receivable mounts, you should vigilantly marshall evidence showing that work was commenced on the project before the recording of existing liens against the property.
The “equity“ problem is especially problematic with owner-occupied property. Homeowners often finance purchases with a loan for greater than 90% of the home’s fair market value. Over the last several years, many homeowners have financed their purchases with loans for 100% of the homes fair market value, or, in some instances, even in excess of 100%. The transaction cost of selling a property is often 10% of its sales price. In other words, upon acquiring their homes, many people have no “net equity” in them.
This problem is further exacerbated by homestead rights which prevent any involuntary liens from attaching to an owner’s first $30,000 of net equity in the property. In most situations, your lien which purports to attach to a homestead will be worthless unless the owner has greater than $30,000 of net equity in it. Establish a good working relationship with a title company so that you can obtain owner’s and encumbrance information on properties at the first sign of trouble.
With the above in mind, it is important to have a good sense of the basic time frames and procedures for pursuing lien claims.
Persons Entitled to Lien
Virtually anyone who performs labor or furnishes material which enhances the value of real property is entitled to a mechanic’s lien. However, a contractor who provides services which merely maintains the value of a property is probably not entitled to a lien. For example, a landscape company which plants a tree is entitled to a lien. A landscape company which trims the tree is probably not entitled to a lien. Some real estate agents are under the misconception that they are entitled to a lien in the event an owner dishonors its listing agreement. Attorneys’ fees are also not lienable.
Perfection of Lien Rights
You must serve a Notice of Intent to file a mechanic’s lien statement on the owner of the property and the principal contractor ten days before you file your lien. You may serve your notice by personal service, or certified mail. An affidavit of the service must be recorded simultaneously with the recording of the lien. The identity and address of the owner should be confirmed precisely from the real estate records. The timing and content requirements for properly filing a lien can be technical and complicated. Because they are involuntary liens, the courts strictly construe the perfection requirement against the lien claimant, so be careful. Lien claimants filing their first half dozen liens, and any lien claimant filing a large lien, should consult their attorney regarding the completion and processing of the necessary forms.
Deadlines for Filing Liens
The general rule is that a lien claimant must file its lien prior to the expiration of four months after the lien claimant’s last work on the property. However, laborers by the day or piece must file their lien within two months after the completion of their work. In general, the time for filing a lien is not affected by a transfer of the property by the owner to a bona fide purchaser who is unaware of a lien claim. As a practical matter, the ease with which you collect on your lien is greatly affected by whether you file before or after a sale. If you file before a sale, it will be much more difficult for the seller to close without dealing with your lien. By recording before the sale you almost assure yourself of a call from a title company, real estate agent, or owner asking to settle the lien claim. If you file after the sale, it is more likely that you will need to foreclose your lien rights to preserve them.
You can file a lien against a property owned by someone other than the owner who didn’t pay you. However, if the principal improvement on the property is a single- or double-family dwelling unit, the lien must be filed within two months of substantial completion or conveyance to a bona fide purchaser, whichever comes first.
As mentioned above, a lien remains in effect for six months after the completion of the improvements, unless the foreclosure action is commenced prior to expiration. If a property is abandoned, it is deemed to be substantially completed three months after abandonment. A lien shall not be effective against a property for more than one year after the date it is recorded, unless an affidavit of non-completion is recorded by the lien claimant within thirty days of the anniversary.
Notice to Disburser
Section 126 of the mechanic’s lien statute allows any lien claimant to serve notice to a “disburser,” informing the disburser of the “general statement of his contract.” A “disburser” includes a construction lender, or anyone else (including a general contractor) who receives construction funds from the lender, owner, or contractor to be disbursed from time to time as work on the project progresses. Upon receipt of the notice, the disburser must “ascertain the amount due to the claimant on any disbursement date, and pay such amount directly to the claimant out of any undisbursed funds available [and due at the time].” If the disburser dishonors its duty, the disburser becomes liable for the claimant’s losses.
Section 127 of the mechanic’s lien statute provides that any funds disbursed to any contractor or subcontractor on any construction project shall be held in trust for the payment of subcontractors, material suppliers, or laborers who have a lien claim against the project. Subsection 127(5) provides that a contractor or subcontractor who violates this trust relationship is guilty of criminal theft.
The Colorado mechanic’s lien statute does not apply to projects owned or constructed by the U.S. government, the state, county, city, or any other governmental agencies of the state. The “Miller Act” governs claims against federal projects, while the Colorado Public Works Act covers state projects. In general, both the Miller Act and the state act require the general contractor to post a bond against which unpaid subs and suppliers may pursue their claims. The Colorado act also provides a means to assert claims against funds retained by the contracting entity. Though it is beyond the scope of this article to discuss these acts in any detail, before furnishing supplies or services to a public works project, you should verify that the bonds have in fact been posted.