FEATURE ARTICLE, MAY 2010

LIEN ON ME 
Charles Jarrell and Jennifer Bercovici

Jarrell

The recession of the past 3 years has claimed a number of blue-chip retailers that would have, even a half decade ago, been considered plum tenants of Southern California retail developments. After these chains go dark, many property owners face not only the difficult task of locating a replacement tenant for the now-empty space, but also the mechanics’ lien claims from contractors and subcontractors that improved space to the ex-tenant’s custom and specific requirements, but were left unpaid when the retailer failed.

In many cases, a property owner may have to pay these claims even though it had no contract with the claimant and even though the improvements are not useable by a subsequent tenant. Additionally, defending against such claims is costly even if the owner has a valid case.

Mechanics’ Lien Laws

Bercovici

Mechanics’ liens are generally creatures of statute and are also a constitutional right in California. Designed to provide protection to contractors, subcontractors and material suppliers that are not paid for their work or materials, the statutory framework sets forth a rigid set of procedural requirements for the claiming and enforcement of a mechanics’ lien. The lien generally allows the claimant to claim an equivalent to the reasonable value of the labor or materials provided. A mechanics’ lien acts as a cloud on title and can prevent the sale or refinancing of the property until it is released.

In many cases, a mechanics’ lien will be recorded against property due to a dispute over payment between a tenant and contractor or subcontractor. However, the present recession has seen an increase in liens that are filed because the tenant that contracted for the work simply goes out of business, leaving the owner as the only source of payment.

Lien Claims: An Ounce of Prevention…

The tenant, not the owner, often hires the general contractor to construct tenant improvements at the leased premises. However, the landlord is not immunized from liability to the contractor simply because the contractor is hired by the tenant. An unpaid contractor, subcontractor or supplier may enforce a mechanics’ lien against the property even where the owner has no relationship with the claimant. In fact, this is the most likely circumstance in which a lien dispute arises. As such, it is important for the property owner to establish procedures to protect itself against mechanics’ liens filed by the tenant’s general contractor, as well as subcontractors and suppliers. Further, many of these issues are best considered at the time the lease is executed, even where there is no dispute on the horizon. There are a number of measures that may afford a property owner some measure of protection against lien claims:

A. Notice of Non-Responsibility

California, like most states, permits a property owner to post a “notice of non-responsibility” at the job site to provide notice that the owner is not responsible for the costs of the improvements. There are a number of specific statements that must be included in such a notice, and the notice must be posted at the property within 10 days from when the owner learns of the project. The notice must also be recorded.

In addition to the statutory requirements, it is also helpful for the owner to send a copy of the notice to the tenant and all known contractors and subcontractors. Owners may also want to take a photograph of the posted notice, with verification of the date of posting (holding up that day’s newspaper next to the notice is a good idea). Owners should also be careful to post the notice where it can be seen by all visitors, and it should not be posted at a location where it might be destroyed or removed.

Even where the owner complies with all of the above requirements, it may still be held responsible on a lien claim where it is determined to be a “participating owner.” Courts have consistently held that a notice of non-responsibility will not insulate an owner against lien claims if the owner “participates” in the project in a variety of respects. For example, where the owner pays for all or a portion of the costs of the project (i.e., via a tenant-improvement allowance), it cannot rely upon the notice of non-responsibility. Additionally, where an owner approves of, directs, mandates or monitors the construction, it loses the protection of the notice. In most contemporary tenant construction projects, it is difficult for a landlord to maintain some level of oversight to ensure the construction at its property is properly completed, without placing itself in the role of a participating owner.

B. Project Oversight/Coordination

Many owners monitor and oversee a construction project at their centers in order to ensure that the contractors and subcontractors are paid, and that work does not continue if the tenant stops paying. To do so, an owner can insist that it is notified of all progress payments and require conditional and periodic lien releases and waivers. It can be difficult in many cases for an owner to effectively monitor all of the projects at its properties in this regard, but it can provide some assurance that a contractor will not work for many weeks or months without being paid, which generally results in the filing of a lien. Of course, if an owner places itself in this role, it cannot later claim it was not a participating owner, so this strategy undermines a notice of non-responsibility.

Some owners elect to retain the contractor directly and recover the costs of the construction by withholding a tenant-improvement allowance or increasing the rent. This affords the greatest degree of control, but also increases the owner’s liability. If there is a dispute, the contractor can claim a breach of contract in addition to its claim of lien. If the tenant goes dark during the project, the owner may have to pay for the full value of the contract even if the remaining work becomes unnecessary because the tenant is gone. On the other hand, by directly hiring the general contractor, the owner can oversee the construction more carefully and take other measures to prevent the filing of liens in this regard. For example, the owner can require that the subcontractors and suppliers supply lien releases before remitting payment to the general contractor. Additional funding mechanisms may also be determined on a case-by-case basis.

C. Tenant Bonding/Indemnity

While most leases require a tenant to defend owners against claims of liens, as well as other claims arising from a construction project, and to indemnify the owner against such claims, these provisions are worthless where the tenant fails or has no assets to satisfy its obligations. An owner may wish to require a tenant to post a bond to cover the costs of a contemplated project in order to give effect to these provisions. The owner may also request that the tenant deposit funds that will be used to pay the general contractor in advance to assure adequate funds are available, but few tenants in today’s market will be willing to do so.

Early Protection

The satisfaction of signing a lease with a premier tenant quickly turns to dismay when the tenant fails. Insult follows injury when an owner is asked to not only suffer the lost rent from such failure, but pay the costs of tenant-directed improvements on top of such failure. Owners must hope for the best, but prepare for the worst. Considering the possibility that they will face a lien claim, they must take steps to protect themselves at the earliest opportunity.

Charles Jarrell is a partner at Allen Matkins in Los Angeles, and Jennifer Bercovici is an associate in the firm’s litigation department.

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