In a perfect real estate development world, construction contractors do a stellar job, their draw request is approved, and lenders pay up—everyone is happy. Alas, as we all know, this is not always how construction loan management progresses, and often both lenders and general contractors find themselves in a pickle with a contractor due to a late payment or slow payment processing. The pickle, in this case, is called a Mechanic’s Lien.
In essence, contractors have the leverage to file a lien and hold a property “in custody” until work performed is paid-in-full. Perhaps not so surprising, consistent results from our annual Construction Payments Report reveals that the overwhelming majority of general contractors and subcontractors have had to file a lien at some point due to slow payments.
Not a very favorable position to be in. Not only do late payments create tension between the relevant parties, but they also create a scenario in which lenders, borrowers, general contractors, and contractors all take a hit, costing everyone precious time and money.
Many factors are at play when it comes to construction loan management, and the delays in payment are rarely due to unscrupulous behavior. So, to help avoid these mishaps, we’re going to share some insights that will help prevent the risk of liens in the future.
But first…how did Mechanic’s Liens come about?
You probably were not expecting a history lesson, so we’ll keep this part as short as possible. Back in the Colonial Era after America declared independence from mother England, a sharp-minded, innovative man by the name of Thomas Jefferson proposed the first liens legislation in the state of Maryland.
This legislation passed, giving contractors and subcontractors (then, mechanics) certain rights which provided them with legal remedy if their general contractor did not pay. Soon enough, every state in the country had a law regarding mechanic’s liens. Now, while similar concepts can be traced back through history to the Ancient Romans themselves, it was Jefferson who effectuated the law in the United States.
So what do Mechanic’s Liens look like today?
Four Examples of Mechanic’s Liens in Real Estate Development
Let’s review four short examples of mechanic’s liens in action.
- The developer of a Los Angeles condominium project entered into a contract with a builder. Several change orders were added to the project, and at completion, the developer refused to pay the additional costs tied to the change orders. The builder then filed a mechanic’s lien for the associated costs and later attempted to foreclose on the mechanic’s lien against the developer and the residents of the condominium building. Ultimately the builder and contractor reached an agreement.
- In 2011, contractor American Disaster Services was granted a mechanic’s lien for non-payment after repairing fire damage in a local home. The owner didn’t pay the full amount of the reparation, arguing that the contractor had done a subpar job. Unfortunately for the homeowner, the court rejected the “lack of substantial performance” argument, as the contractor had already completed 70% of the work before the owner started hindering progress. All in all, the contractor was the unanimous victor.
- Also in 2011, Kiefer Construction gained a partial mechanic’s lien, as the court denied the homeowner’s “lack of substantial performance” argument. At the same time, the court also rejected the contractor’s request to be paid the full contract price. Eventually, the contractor recovered the contract price of his work, minus deductions for defects or incompletion. But, in this case, the contractor only partially prevailed against the homeowner.
- Finally, a school district contracted with a general contractor to build a new gymnasium and football stadium. The general contractor hired subcontractors to perform the work. All work had been completed, yet the general contractor encountered financial problems on the project and held back payment to the subcontractor. The subcontractor filed a lien and was eventually paid the full amount due plus interest penalties, attorney fees and costs. The court ruled in favor of the subcontractor arguing that the general contractor cannot use subcontractor’s money to fund its own cash flow.
In all cases, all parties—lenders, borrowers, contractors, subcontractor, and even condominium owners—suffered.
To receive payment after completing work, a contractor includes a conditional lien waiver and release alongside invoices and receipts. What is a conditional lien release? It discharges all claimant rights with the condition that payment has been received and processed. What is an unconditional lien release? It discharges all claimant rights with no stipulations after receipt of payment.
Construction loan software aids in construction loan management and in preventing mechanic lien issues for all parties. Let’s take a look. By the way, you’ll love this next section if you are:
- A construction loan administrator that is accustomed to sifting through 100’s of documents contained within a draw request
- A general contractor currently using traditional methods of making, documenting, and tracking your payments to subcontractors
- A contractor wishing you could get your payments faster
Three Ways Construction Loan Software Leads to Lien-Free Completion
- For starters, one of the hottest related trends today is Machine Learning in Banking and Construction Loan Administration. By way of sophisticated algorithms, optical character recognition, and predictive modeling, construction loan software can now parse and pull data from draw packages. It then organizes the data and conducts checks and balances—reducing human error while dramatically increasing loan efficiency ratios.
- In addition, construction loan software can digitize and monitor all aspects of a construction draw. The software tracks the scope of work, budget, invoices, receipts, and change orders related to all of the work like cement, plumbing, electricity, landscaping; you name it. It monitors all transactions too, ranging from the initial contract amount to the final payment, ensuring it is all documented in writing, which helps reduce issues related to liens. So, which is it—construction loan software, loan monitoring software, or construction draw software? It’s all three!
- Construction loan software also automates the release of unconditional liens at the point of payment disbursement. For example, in states that allow E-signatures without notary involvement, general contractors can automate payments to contractors via ACH or a physical check. These transactions are all managed and tracked within the software and reduce the risk of an unconditional lien not being submitted after the release of payment. It also means general contractors no longer have to manually journal, cut, and distribute checks or track down 1099’s and lien waivers—saving hours a month in administrative time
To Summarize: Embrace the Mechanic’s Lien
Before automation and construction loan software was available, stakeholders associated with the construction process had a tough time monitoring documentation, reconciling draw disbursements, and keeping legal disputes at bay due to the time-consuming and delicate nature of traditional construction loan management. Luckily, construction loan software is here to automate and simplify the entire process. It’s helping lenders, borrowers, construction loan administrators, general contractors, and contractors maximize efficiency and productivity.
