Lien Laws and Avoiding Construction Delays

lien waivers 2Money flows on a construction project, from lender to borrower to general contractor to subcontractor and supplier—that’s a lot of changing hands, and that means risk. This is why our lending clients often ask for advice on the specifics of lien laws and lien waivers. For those active in construction lending, one version or another of a lien waiver document likely crosses your computer screen at least once a day. These files are a lot like receipts—receipts which state that, in the hierarchy of a construction project, someone has paid someone for services rendered at or related to a job site. “But,” as attorney Brooks Clark points out, “it’s not as simple as that.”

Is anything, ever?

Brooks is a partner at Polsinelli, a powerhouse law firm with experience in a vast array of industries, from chemical manufacturing to start-up ventures. His focus is the real estate sector. After hearing him touch on the topic of lien waivers at a panel I attended, I reached out to see if he could provide additional insight from his perspective as a real estate attorney. He obliged, and the two of us sat down for lunch on Manhattan’s East Side.

First, how do lien waivers work? Construction loans, whether through smaller community banks that dabble in construction lending or larger national entities that specialize in that arena, often require funds to be dispersed on a periodic basis, throughout the duration of a construction project rather than upfront and all at once. Typically, a borrower comes to you for monthly draws, looking for funding based on his general contractor’s progress that month. The GC then provides payment to his subcontractors and, in return, is handed lien waivers that state the subcontractor has been paid for work completed during that period. These waivers ensure a contractor, subcontractor, or supplier (collectively called “mechanics” in legalese) cannot file a lien impeding progress on a project due to lack of payment.

Complications, however, inevitably arise. Explains Brooks, “You have conditional waivers, unconditional waivers (neither of which actually apply in New York), partial waivers, final waivers, and in some states, no waivers at all!” This is why it’s important to know the specific lien laws in your project’s state. “If you’re a multi-state lender,” Brooks advises, “get yourself familiarized in those locales as much as possible because many states have differing statutes.”

lien waiver diagramIf you’re lending on construction projects, becoming familiar with lien laws will help ensure that you, as the lender, will not be held liable for unpaid expenses that might present themselves in the case of foreclosure. During foreclosure, payments to unpaid subcontractors get satisfied first; they are “primed,” or granted higher priority than other expenses. Say you advanced $50,000,000 and there’s $50,000,000 outstanding to subcontractors; guess who gets paid first?

Regardless of which state you are lending in, make sure the contracts you have with your borrowers outline waiver specifics. Normally waivers won’t come with the first draw packet because nobody’s been paid yet, but be sure that you and your construction consultant are on the same page for that second draw and all subsequent draws, when waivers should arrive from the GC, subcontractors, and suppliers. Waivers should be correct down to the exact cent that was spent for the draw prior. Insist that your consultant or internal team members responsible for document review remain vigilant every time these documents are submitted. Insist also, preferably through contractual agreements, that full transparency is maintained through the entire payment chain. The importance of that last statement, I’ve learned the hard way.

“No, you will not receive lien waivers from my subcontractors,” I was actually told by a general contractor of a $50,000,000 multifamily project in New York City a few years back. “That’s private information.” When my client, the loan officer for the local bank funding the project backed the GC, I was speechless. “He’s got a closed book contract, and his GC lien waiver will be enough,” the credit officer told me. “Besides, we have a relationship with the borrower on this one.” Despite my insistence on total transparency, the project progressed with nobody confirming where the money was actually going. Multiple liens were filed on the project during its later stages and finalization of the Certificate of Occupancy was delayed by almost a year because clean title was unobtainable. Lesson learned.

When you’ve got a lender involved, Brooks agrees, “there should never be any kind of closed book deal whatsoever.” A lot of times a general contractor will pay his subs for one job from another job. If you think it’s occurring, you might want to consider paying subs directly to ensure a guarantee of payment is fulfilled. Lack of transparency is a huge risk to those funding the projects.

Outlining waiver specifics early will eliminate surprises when you pull title before funding each month. If a bank cannot fund the monthly draw because of a lien, the whole project gets put on hold because no one is getting paid. This results in delays and, possibly, further liens.

Construction lending is one of the riskiest types of lending. If you’re not an expert attorney like Brooks, you could spend hours trying to untangle the legal details of a deal. This is why I’m reminded at lunch to always involve the experts early on. If you don’t have a “Brooks” of your own, start with the bank attorney. He or she will help you word your building loan agreement and answer questions like, “Can you tell me what sort of protections this state offers construction lenders with respect to mechanics and suppliers?”

As clients of Nova, feel free to use us as a resource if you have questions on the lien laws in your states of operation. We’ll dig as deep as necessary before a complete and comfortable level of understanding is reached, and collectively we will all benefit from the research. On the deals that we are monitoring for you, rest assured that we will be tracking the draw funds to the penny as dollars pass from your borrower to your contractors and then to your contractors’ subcontractors and suppliers. As a Nova client, we want you to be protected.

About Brooks Clark

Brooks Clark is focused on results, whether representing a client as issuer’s counsel on a highly structured real estate finance deal with many competing interests or as lender’s counsel on a building loan that requires a quick turnaround on an aggressive timetable. His experience working with both institutional lenders and property owners allows him to see both viewpoints and quickly craft an effective solution.

View his bio on the POLSINELLI website here.

Author

Matt headshotMatt Pappalardo

Construction Services Director

Nova Consulting Group Inc.

(917) 232-1056

matt.pappalardo@novaconsulting.com

 

 

 

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