Liens for Everyone (Updated)

Pennsylvania used to be an unforgiving place for a subcontractor seeking to file a mechanics lien.  For over thirty years, with few exceptions, higher tier contractors could waive a subcontractor’s lien rights by filing lien waivers before work began on the project.  The onus was on the subcontractor to check with the Prothonotary to see if a lien waiver had been filed for a particular project and, thus, whether it had any lien rights.  Because pre-construction lien waivers were routine there were only a few instances were subcontractors could file mechanics liens.

However, in 2007, the General Assembly greatly increased the pool of potential lien claimants when it amended the Lien Law and made pre-construction and contractual lien waivers void as a matter of public policy.    Still, while the Assembly signaled a shift towards favoring contractors with the 2007 amendments, the courts still took a hard line in interpreting Lien Law and continued to “strictly construe” the Lien Law’s requirements, meaning even the slightest deviation from the Lien Law’s requirements could result in a lien being stricken.  Thus, the courts muted any intended liberalization of the Lien Law by the Assembly.

At least that was the case until June of last year when the Superior Court issued the first in a series of opinions liberalizing the interpretation of the Lien Law and signaling a bias in favor of contractors and subcontractors.  In June 2011, the Superior Court issued an opinion in B.N. Excavating, Inc. v. PBC Hollow-A, L.P., where the Court liberalized the definition of when excavation work is “lienable.”  Prior to B.N. Excavating, the prevailing view was the in order for excavation work to support a mechanics lien claim the work must be part of a completed structure.  However, in B.N. Excavating, the Superior Court reasoned “we do not interpret the [Mechanics Lien Law] . . . as creating a bright-line rule that a mechanic’s lien can never attach to land absent an erected structure.”

Then in January 2012, the Superior Court issued its “earthquake” opinion in Bricklayers of Western Pennsylvania Combined Funds, Inc. v. Scott’s Development Company, where the Court overturned decades of precedent and held that “[p]ursuant to the plain language of 1 Pa .C.S.A. § 1928(a) and (c), the Mechanic’s Lien Law of 1963 cannot be strictly construed on the basis that it is in derogation of the common law. See 1 Pa.C.S.A. § 1928(a), (c)” and permitted labor union health and welfare funds to file mechanics liens against a project!

Most recently, in Commerce Bank/Harrisburg, N.A., v. Kessler, the Superior Court held that an open-end mortgage does not have priority over a mechanics’ lien filed after the mortgage is recorded if (1) work on the property began prior to the recording of the mortgage; and (2) any portion of the loan proceeds are used to fund something other than the “cost of completing erection, construction, alteration or repair of the mortgaged premises secured by the open-end mortgage.”

The Court reached this conclusion despite what appears to be a clear definition of when an open end mortgage is superior to a mechanics lien.  Under Section 1508(c) of the Lien Law a lien is subordinate to an open-end mortgage “the proceeds of which are used to pay all or a part of the cost of completing erection, construction, alteration or repair of the mortgaged premises secured by the open-end mortgage.”  Apparently, the Superior Court did not think that part of the open end mortgage proceeds could be used to fund construction and the other part of the proceeds pay for other items such as closing costs, old mortgages, unpaid taxes, ect. – as is commonly the case –  for an open end mortgage to retain priority over a mechanics lien.  Instead the Court held:

“[w]e interpret the use of the terms “the proceeds” to mean all of the proceeds.”

Obviously, lenders and title insurances companies are concerned about this decision and are looking for ways to protect themselves. Most of the recommendations I have seen do not make any sense, except for the recommendation that lenders pay contractors and subcontractors directly, which is a great idea for a myriad of other reasons the discussion of which is beyond this post.

There are also several questions that this opinion raises:

1.  The Court agreed with the appellant’s argument that so long as a lender could show that $1 was spent on construction the lender could retain priority and stated that if lenders were permit to do so an absurd result would occur.  However, couldn’t the same argument now be said from the contractor’s position?  So long as $1 of the construction loan is used for purposes other than construction is the lender’s priority not defeated?

2.  How does a lender control 100% of the loan proceeds?  I.e. how does it insure that 100% of the loan proceeds are used for construction thereby maintain its priority?

3.  Senior position is a basic premises upon which a loan is underwritten.  If lenders cannot assure senior position what does that mean for underwriting of construction loans?

There is one question that the Superior Court did an answer  “do I have lien rights?”, the answer, at least from the current Superior Court, is YES.

Alert – PA House Passes Bill Making Major Changes to the Mechanics Lien Law

On March 27, 2012, the Pennsylvania House of Representatives passed HB 1602, a bill that makes major changes to Pennsylvania’s mechanics lien law and if passed by the Senate and signed into law will impact any contractor working in Pennsylvania.  All contractors should be aware that HB 1602 weakens a contractor’s most effective weapon against non-payment, the mechanics lien.

1.  No Right to Lien a Residential Project.

HB 1602 amends Section 301 of the Mechanics Lien Law, 49 P.S. Section 1301, adding a sub-part (b), which states that a subcontractor shall no longer have the right to lien a residential project when the owner has paid the general contractor in full.  While other States, like New Jersey, have different rules for filing mechanics liens against residential property, I am not aware of any State that prohibits the filing of a mechanics lien against a residential property outright, as HB 1602 does.

HB 1602 would effect small contractors the most and it would take away a cost effective and efficient means for ensuring payment.  The amounts owed on most residential projects are small.  However, these small amounts have a huge impact on a small construction firm’s cash flow.  Moreover, most small construction firms do not have the resources to devote to litigation for such small amounts, especially when litigation costs can easily exceed the amount owed and collection from a general contractor is often doubtful.

2.  Notice of Commencement

The other major change to the Mechanics Lien law that HB 1602 makes concerns the prerequisites to filing a mechanics lien.   Under HB 1602,  an owner can require a subcontractor to provide a “notice of furnishing” to the owner within twenty days of its first day of work in order to preserve its mechanics lien rights.  A subcontractor is required to provide the owner with a notice of furnishing when the owner has filed a notice of commencement in the “State Construction Notices Directory” maintained by the Department of Labor and Industry.

An owner files a Notice of Commencement by filing it with the Department of Labor and Industry and it must include:

• the name and address of the general contractor, name and location of the project,
• legal description of the property upon which the improvements are being made,
• name, address, and email address of the legal record owner of the property,
• name, address, and email address of the person other than the owner at whose direction the improvements are being made (I would imagine this means a tenant), and
• name, address, and email address of the surety if performance and payment bonds are posted (this makes no sense because if a payment bond is posted then subcontractors probably have no lien rights anyway.

Additionally, the owner must post a copy of this notice conspicuously at the project site before any “physical work” commences and ensure that the posting remains posted during the duration of the project.

For the subcontractor’s part, when a Notice of Furnishing is required it must state:

• a general description of the subcontractor’s work;
• name and address of the subcontractor; and
• name and address of the person with whom the subcontractor contracted.

Basically, all of the same information that a subcontractor is already required to give when it files it formal notice of intention to file a mechanics lien under Section 501.  Moreover, HB 1602 dictates the format of the Notice of Furnishing.

This Legislation is a disaster and fails my test for supporting legislation:

(a) is there a compelling reason for changing current policy?, and (b) does it makes sense?

The answer to both questions is NO and I am not sure who this bill is intended to benefit.  It is entirely unclear what problems with the current lien law this bill would solve.  I do not see it benefiting owners who must not only pay a fee to file a Notice of Commencement but also assure that the Notice is posted and maintained.  Additionally, it clearly makes it more difficult for subcontractors to file a mechanics lien, which I am not sure why we want a policy against that.

Hopefully, the Senate comes to its senses and defeats this Bill.  We will be sure to keep you posted.

Mechanics Lien Earthquake: Everything You Learned About the Pennsylvania Mechanics Lien Law Is Now Wrong.

For years construction lawyers in Pennsylvania have been taught that the requirements of the Mechanics Lien Law must be strictly followed or a mechanics lien claim will be stricken and lost.  In decades of precedent, it has been repeatedly stated that the Pennsylvania Mechanics Lien Law is a “creature of statute in derogation of the common law” and, therefore, in order for a lien claim to be valid it  must be filed in strict compliance with the Mechanics Lien Law.

Construction attorneys representing owners, whose property became subject to a mechanics lien, have used this well established principal to dismiss mechanics liens for any variety of deviations from the Mechanics Lien Law. Failing to attach a written copy of the construction contract to the lien; failing to properly identify the owner of the property; failing to properly serve the lien; and failing to give proper notice are some examples of deviations from the strict requirements of the Mechanics Lien Law that have resulted in mechanics liens being dismissed.

However, on January 6, 2012, the Superior Court in Bricklayers of Western Pennsylvania Combined Funds, Inc. v. Scott’s Development Company, 2012 WL 29299. overturned decades of precedent and held that “[p]ursuant to the plain language of 1 Pa .C.S.A. § 1928(a) and (c), the Mechanic’s Lien Law of 1963 cannot be strictly construed on the basis that it is in derogation of the common law. See 1 Pa.C.S.A. § 1928(a), (c).”  A copy of the decision is available here.

In Bricklayers, the Superior Court addressed the viability of mechanics lien claims that the trustees of employee benefit funds filed  for unpaid contributions owed to union members under collective bargaining agreements between a contractor and the unions.    The trial court concluded that the union members were not “subcontractors” under the Mechanics Lien Law because the collective bargaining agreements were not traditional subcontractor agreements, and the union members were employees and/or laborers of a contractor. The Superior Court overruled the trial court and concluded “that under the specific facts presented in this case, the unions are subcontractors and given the unique legal relationship that exists between the trustee and the union, the trustee has standing to assert a mechanics’ lien claim on behalf of the union.”

The Court refused to strictly construe the Mechanics Lien Law as it had done in the past because “the ‘derogation of common law’ precept violates the commands of 1 Pa.C.S.A. § 1928(a) and (c)”   Thus,  “[it] should no longer be used in connection with the Mechanics Lien Law of 1963.”    Moreover, the Court held  “[t]his is especially true since Sampson–Miller,the source of the strict construction rule, erroneously rested on case law interpreting the Mechanics’ Lien Law of 1901 and inaccurately transposed it to the successor statute, the Mechanics’ Lien Law of 1963.”  Therefore, the Court concluded, “the statute must be liberally construed to effect [its] objects and to promote justice.”  Based upon its holding, the Superior Court for the first time permitted unpaid unions – through their trustee fiduciaries – to assert a mechanics lien claim for unpaid benefit funds.

Can An Equipment Rental Company File a Mechanics Lien?

Yesterday, I presented at a CLE on Pennsylvania’s Mechanics Lien Law.  As usual, I received great questions from those in attendance.  One questioner asked an interesting questions regarding whether an equipment rental company was prohibited from filing a mechanics lien in Pennsylvania.  I thought the answer was fairly easy and gave a quick “No” response.  However, after emailing with the questioner following the presentation I realized that the question was more nuanced than I originally thought.  And, after further review, I believe the answer is “it depends.”

Three sections of the Pennsylvania Mechanics Lien Law make this question more complex than it appears.  First, let’s start by seeing who the Lien Law says is entitled to file a Mechanics Lien as a matter of right.  Section 1301 of the Lien Law states that a contractor or subcontractor is entitled to a mechancis lien to secure a debt incurred “for labor or materials furnished in the erection or construction, or the alteration or repair of the improvement, provided that the amount of the claim, other than amounts determined by apportionment under section 306(b) of this act, shall exceed five hundred dollars ($500).”  49 Pa. Stat. Ann. § 1301 (West).

Next, let’s look at what the Lien Law defines as “labor and materials furnished.”  According to Section 1201(9)  of the Lien Law “Labor” includes the furnishing of skill or superintendence.”  49 Pa. Stat. Ann. § 1201 (West).  According to Section 1201(7) of the Lien Law “materials means building materials and supplies of all kinds, and also includes fixtures, machinery and equipment reasonably necessary to and incorporated into the improvement.”  49 Pa. Stat. Ann. § 1201 (West).

If we stopped out analysis here, then the answer to our question appears straightforward because clearly the Lien Law includes “equipment reasonable necessary to . . . the improvement.”  Therefore, pursuant to Section 1301, a lien would be available for rental of such equipment, provided all of the other factors necessary for filing and perfecting a mechanics lien are met.

However, as the questioner pointed out Section 1303(e) of the Lien Law states ” Security interests. No lien shall be allowed for that portion of a debt representing the contract price of any materials against which the claimant holds or has claimed a security interest under the Pennsylvania Uniform Commercial Code or to which he has reserved title or the right to reacquire title.”  49 Pa. Stat. Ann. § 1303 (West)  Clearly, a company that rents equipment retains title to that equipment.  So, is a rental equipment company out of luck if it needs to file a mechanics lien?

If the rental company provides labor to operate the equipment, then it appears that the right to lien is clear because the labor provided was utilized in construction of the project.

But what about a rental equipment company that did not provide labor and just rents equipment to a contractor who will supply the labor?  Well, there is no controlling case law on point.  However, there are a few pre-1963 Lien Law cases that say equipment furnished to a project that is not incorporated into the project as a fixture is not lienable.  Moreover, the Westmoreland County Court of Common Pleas held “the equipment or fixtures must be of a permanent character which will pass as a part of the freehold and reasonably necessary to equip the building for the purpose for which it is intended.”  Joyce v. Sarnelli, 29 Pa. D. & C.3d 544, 547 (Pa. Com. Pl. 1984).  However, the question before the Court of Common Pleas Court involved whether refrigeration equipment used in a supermarket was lienable.  While the Court ruled that since the refrigeration equipment was not of a permanent quality of the building and thus lienable, it also should be noted that the refrigeration equipment was not used to construction the building either.

Moreover, the Lien Law’s use of the word “and” in the clause “equipment reasonably necessary to and incorporated into the improvement” seems to indicate that the equipment furnished must become a permanent part of the improvement.

Still its a close call.  Certainly, there is a good faith basis for a company that only rents equipment without providing labor to claim a lien.  Who knows, maybe that lien claim will end up with the Superior Court to clarify the issue.  In any event, great question!

Navigating a “Construction” Bankruptcy

Stick around long enough and dealing with a bankruptcy during or after a construction project is inevitable.  Moreover, when a member of the construction “chain” – owner, contractor, or subcontractor – files for bankruptcy everyone is effected.

Receiving a Trustee’s “preference letters” might be largest cause of irate phone calls from clients to their attorneys.  Subcontractors and suppliers, in particular, are flabbergasted when they are told that the Bankruptcy Code permits a Trustee to require repayment of money even if the payment was due when the  debtor made it.  The Trustee’s “strong arm” power is a fitting moniker for Trustee’s ability to recover money rightfully owed when payment was made within 90 days of the date debtor filed bankruptcy.

In this month’s Construction Executive Magazine,  Michael R. King of Gammage & Burnham in Phoenix, gives a refresher  on what a contractor’s options are in responding to or defending against a Trustee’s demand for repayment of a “preferential” transfer.  The article also reminds us that further efforts to perfect, but not to collect or enforce, a mechanics lien are not subject to the Bankruptcy Code’s automatic stay provisions.  I recommend saving the article to your favorites as a quick reference guide for when you next receive a preference letter.

What the article does not discuss is an unpaid subcontractor’s super priority in unpaid funds either withheld from a debtor or retained by the debtor.  I have long been an advocate of subcontractors aggressively pursuing payment using this super priority. I am surprised how few subcontractors and suppliers pursue this claim.

Next time you have a payment owed form a debtor that files for bankruptcy, don’t simply write it off.  Instead, take a minute to explore your options.  What you will find is that you are not as bad off as you think.