Understanding Mechanic’s Liens and Arbitration Provisions

As construction companies continue to operate under the stresses of the COVID-19 pandemic and social unrest, projects are starting and stopping as a result. These interrupted schedules, along with our overall disrupted economy, can increase the risk of non-payment. What should you do if there is an arbitration provision in your contract but you want to file a mechanic’s lien to protect your payment rights? First, it is useful to understand the different roles of an arbitration dispute resolution process versus a contractor’s mechanic’s lien rights.

Mechanic’s liens are a remedy created by state statutes that provide security for amounts contractors are owed under their contracts. When a contractor provides labor or material to a project, it has the right to a lien against the property being improved — that is, the actual real estate upon which the project sits. In the event of nonpayment, a mechanic’s lien and subsequent foreclosure action can force the sale of the property in order to pay the amount owed. The sale of the property subject to the mechanic’s lien provides a source of funds to pay for the value of work completed and not paid, but the lien, by itself, does not determine the amount owed.

If your contract contains an arbitration clause, an arbitrator will determine the amount the contractor is actually owed (if any) under the contract. Often, nonpayment occurs due to some dispute over the work completed by the contractor. When there is an arbitration clause, the arbitration hearing — rather than a court — is the forum in which the evidence of the value of work completed is presented and the arbitrator will use this evidence to determine how much money (if any) is owed to the contractor.

Arbitration hearings and mechanic’s liens are thus parallel and separate paths that: (a) in the case of arbitration, determine the amount owed; and (b) in the case of the mechanic’s lien, provide security for ultimate payment of the amount that is determined to be owed in the arbitration. It is important to bear in mind that mechanic’s liens are regulated by state statutes with tight timelines and, often, many strict filing rules. These rules can be confusing and it is easy for an inexperienced contractor to make mistakes. Accordingly, a contractor should first take all the necessary steps to preserve its statutory lien rights before attempting to demand arbitration under your contract.

To preserve your lien rights, there are three things you need to evaluate right away:

• Check your state’s laws — Mechanic’s liens have strict statutory requirements, which vary state by state. It is important to determine what the statutory requirements are for the state you are working in — small technical errors can invalidate liens — and be aware of possible pre-lien notice requirements.
• Time is of the essence — Most mechanic’s lien statutes require that the mechanic’s lien be filed within a certain number of days after the contractor’s last date of work. In addition, the lien typically must be foreclosed upon within a certain time period. It is important to evaluate and prepare your lien filing in advance of any state statutory deadlines and coordinate any foreclosure action with your arbitration demand.
• Preserve your statutory rights — Record your mechanic’s lien on time (typically with the county registrar/recorder), following all the statutory requirements. Calendar any dates by which you need to foreclose on your lien.

Then what?

Once your mechanic’s lien is recorded, it provides security for payment of the amount stated in this lien statement. However, the mechanic’s lien does not establish that the contractor is actually entitled to that amount. Once the lien is on file, there are a variety of options to consider:

• Generally, there is a period of time (typically a year) by which you need to foreclose on the lien. During this time period you can:
  • Negotiate with the project owner to resolve your dispute and/or
  • Initiate and proceed with arbitration.
• However, if your foreclosure deadline is approaching, you must comply with the statute and timely initiate your foreclosure action in state court. You can initiate the foreclosure action and move to stay the action pending arbitration. After your arbitrator has issued an award, if you remain unpaid, you can move to confirm the award in the lien foreclosure action, with the property providing security (via a sheriff’s sale) for payment of the amount of the award.
• After the foreclosure action is initiated, the landowner or any other interested party (such as a bank) may substitute a bond in place of your mechanic’s lien. In that instance, the bond serves as the security for payment, instead of the lien on the land. If a bond is substituted, the mechanic’s lien would need to be released.

Takeaway

Arbitration demands and mechanic’s liens are separate and parallel paths for contractors to pursue and secure payment on construction projects. The arbitration determines how much the contractor is owed, while the mechanic’s lien provides security for payment of the amount owed. Due to their statutory nature, mechanic’s liens can be confusing and complicated, particularly when coupled with arbitration clauses. Remember to protect your statutory rights first and that time is of the essence when dealing with mechanic’s liens. The attorneys of Faegre Drinker are happy to help you evaluate your needs.

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