Contracts
Jun. 21, 2002
Legislature Should Rethink Policy on Mechanics Liens
Forum Column - By James Acret - Though poor in lucidity, the mechanics lien law is abundantly rich in unintended consequences, and its enforcement often results in flagrant injustice.
By James Acret
Though poor in lucidity, the mechanics lien law is abundantly rich in unintended consequences, and its enforcement often results in flagrant injustice.
The purpose of the mechanics lien is to prevent the unjust enrichment of an owner at the expense of a contractor. It would be unjust for an owner to take the product of a contractor's labor and not pay for it. The mechanics lien allows a contractor who has improved the value of an owner's property to exact payment by foreclosing on the property that was improved.
But foreclosure of a lien may cause serious injustice when an owner's property is sold to pay a debt that was not incurred by the owner but by the contractor or a subcontractor. A stranger suddenly comes into your life and presents you with a bill for a debt you did not incur.
Mechanics lien remedies appear designed to protect innocent and vulnerable contractors from crafty homeowners.
A free marketplace would allow owners to waive lien rights in advance. But our Legislature has endowed the mechanics lien claim with the inevitability of an earthquake: The statute invalidates blanket waivers and voids specific statutory releases signed by an unpaid subcontractor or supplier.
The statutory anti-waiver provision was so strongly enforced in William R. Clarke Corp. v. Safeco Insurance Co., 15 Cal.4th 882 (1997), as to invalidate all pay-if-paid clauses. The court held that a pay-if-paid clause, whereby payment to the subcontractor is made conditional on the prime contractor getting paid, has the same effect as an advance waiver of lien rights and is therefore void. This decision gave prime contractors traction with the Legislature. They argued that the enhancement of subcontractor claims should be offset by increasing the prime contractors' rights against owners.
The Legislature responded by enacting Civil Code Section 3110.5, which went into effect Jan. 1. With many exceptions, owners of commercial and industrial projects who contract for improvements worth more than $1 million must put up security for the benefit of the prime contractor. The amount of the security ranges from 15 percent to 25 percent of the contract price. The security, in the form of a payment bond, a deposit in escrow or a letter of credit, must be posted before commencement of construction.
Now for the unintended consequences.
Many owners of commercial and industrial property can't pay 15 percent upfront. Picture an owner getting ready to sign a $5 million construction contract. Is it likely that a spare $750,000 is uncommitted and available for contractor security?
In order to get a bond, an owner would have to post at least 100 percent collateral. Inability to meet this requirement could stop many projects, and contractors can't waive the requirement.
If the contractor has bonding capacity, though, there may be a way out. The contractor can furnish the bond or somehow enable the owner to make bond.
Section 3110.5 was designed to protect prime contractors against subcontractor claims as a substitute for the pay-if-paid clause. The drafters, in their ignorance, made the owner-posted security vulnerable to claims by subcontractors and suppliers. So a material supplier stiffed by a subcontractor can dilute or exhaust the security that was intended for the benefit of the prime contractor by suing on the bond or filing a stop notice. So it came to pass that a remedy intended to protect prime contractors against subcontractors instead protects subcontractors against prime contractors.
Subcontractors and suppliers are less rigorous in extending credit when money unpaid by a deadbeat can be recouped by lien foreclosure. Whether credit should be advanced is a question that arises in most commercial transactions. Merchants can deal c.o.d., but most find it advantageous to extend credit and exhibit astonishing ingenuity in crafting instruments to secure debt.
Lawyers make good livings drafting instruments adapted to the nuances of specific transactions. There is no evidence that contractors or their suppliers or their lawyers cannot similarly adapt their construction contracts and purchase orders.
The Legislature has taken away from contractors the right to waive mechanics lien rights, the ability to fully release mechanics lien rights and the right to contract for commercial and industrial projects without posted security. It is time to reconsider. Can California trust contractors, subcontractors and material suppliers to evaluate the creditworthiness of their customers? Perhaps the Legislature should restore freedom of contract to this segment of the construction marketplace.
The equitable lien doctrine gives an equitable lien to any unpaid supplier of construction to the extent that a property owner has been unjustly enriched. As it applies to construction loan accounts, the equitable lien doctrine was abolished in 1969, but it still exists for real estate, and it fulfills the same function as the mechanics lien in preventing unjust enrichment of owners.
James Acret is of-counsel to Thelen Reid & Priest in Los Angeles.
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