Avoid double jeopardy on your construction project

How commercial property owners can protect themselves against mechanic's liens.

Everyone recognizes the importance of paying bills. However, imagine being the owner of a construction project and finding out that even though you paid all your bills, you have to pay the bills for someone else with whom you do not have any type of agreement. If you do not pay those bills, that person can file a lien on your property and ultimately sell it at a foreclosure sale.

This is not far-fetched; it is reality. Welcome to the world of commercial construction, where an innocent owner can be forced to pay for its construction not once, but twice.

This article explains how Ohio's mechanic's lien law allows that to happen and lays out steps commercial property owners can take to avoid this risk of double jeopardy. The law and precautions described apply only to commercial projects; for residential projects, state law protects homeowners from having to pay twice for the same work.

Ohio's mechanic's lien law provides that practically anyone who works on a commercial construction project is entitled to file a mechanic's lien against the project if he or she does not get paid. Ultimately, the property can be sold at a foreclosure sale to pay off the mechanic's liens.

You say, "So what? The owner should just pay its bills." However, even if the owner pays its bills, liens can be filed against the property. To understand how that can happen, one needs to understand how most construction projects are performed.

Most owners hire general contractors to build their buildings. The general contractors then hire subcontractors to perform most, if not all, of the work necessary for the project. The hiring of subcontractors is where problems arise.

The owner receives bills from the general contractor only. The general contractor pays the subcontractors. If a subcontractor demonstrates that it was not paid by the general contractor, it is entitled to file a lien against the property where the construction occurred—even if the owner can prove that it paid the general contractor. Thus, the owner is faced with the prospect of either paying the subcontractor directly for work for which the owner already paid the general contractor or the subcontractor can foreclose against the property. Neither of these options is particularly attractive to the owner.

You may ask, "How often do general contractors not pay their subcontractors?" The answer, unfortunately, is quite often. Sometimes general contractors use money from one construction project to pay subcontractors from a past project. Sometimes general contractors file bankruptcy or otherwise cease to exist because of financial problems. Some general contractors are simply thieves, taking money belonging to the subcontractors and running away with it.

But don't worry, owners of commercial properties! There are steps that an owner can take to protect itself from this risk of double jeopardy.

First, before construction begins, the owner should ensure that a notice of commencement is recorded with the appropriate county office in the county where the project is located. This will often be performed by the owner's lender, but the owner should make sure it happens. The notice of commencement should also be posted in a conspicuous place at the project. Additionally, if a subcontractor requests a copy of the notice of commencement, one should be provided no later than 10 days after it is requested.

If these steps are taken, any subcontractor that wishes to file a mechanic's lien will have to serve the owner with a notice of furnishing. The purpose of the notice of furnishing is to let the owner know that the subcontractor is providing work at the project. If the subcontractor does not provide the notice of furnishing, it cannot file a mechanic's lien, even if it is not paid. Armed with this knowledge, the owner can take steps to protect itself from mechanic's liens.

Most construction projects of any duration are paid on a periodic basis, normally monthly. The general contractor submits an application for payment, often called a draw request. Once the request is approved, the owner (generally through its lender) makes the payment (less retention, which is discussed below).

During the payment application process, the owner should require the general contractor to provide it with partial mechanic's lien waivers from all the subcontractors that provided services during the relevant period. The owner will know who these subcontractors are because it will have received notices of furnishing from them. Ohio law recognizes the enforceability of these lien waivers, in which the subcontractors state that they have been paid as of a certain date and waive the right to file mechanic's liens for work done through that date. The owner can compare the lien waivers it receives with the list of subcontractors identified in the notices of furnishing it has received to make sure that those subcontractors are being paid.

Too often, the only lien waiver provided with payment applications is signed by the general contractor. It states that the subcontractors have been paid—but it is practically worthless. It does nothing to protect the owner from subcontractors' lien claims. While it does subject the unscrupulous general contractor to a possible perjury charge, it does little good to the owner whose project becomes riddled with mechanic's liens because the general contractor is not paying its subcontractors.

In a perfect world, the owner, the general contractor and the subcontractors would all sit in one room at the time of payment, and the lien waivers from the subcontractors would be for all work performed through the time of payment. As a practical matter, this rarely happens. Generally, the best an owner can do is obtain lien waivers for the prior month. For example, when the general contractor submits its application for payment for the month of February, the owner should at least receive lien waivers from all the subcontractors through the end of January.

If the owner receives even a hint of trouble on the project (i.e., communications from subcontractors alleging nonpayment or worse, an actual mechanic's lien), it should not hesitate to require lien waivers for the current month before releasing payment. This may create extra work on the part of all parties. However, the owner should insist on this extra work to protect itself from mechanic's liens.

Commercial owners should also negotiate the withholding of retention in their contracts with general contractors. Retention is an amount withheld by the owner (normally 10 percent) from each monthly payment until the project is complete. This retention serves a number of purposes, not the least of which is to make sure all the subcontractors have been paid. Before retention is released, the general contractor should have to provide final lien waivers from all subcontractors stating that they have been paid in full.

Ohio's mechanic's lien laws are complex. Taking the steps outlined above dramatically reduces the risk of double jeopardy. Remember that the resolution of legal issues depends on the specific facts of a particular situation and the applicable law. If you have specific questions regarding a construction issue, please contact Tim McGarry or any other attorney at Nicola, Gudbranson & Cooper.

—Tim McGarry
tmcgarry@nicola.com