Lien waivers have an important, even critical, place in construction payment. The parties closest to the money are highly motivated to make sure the project proceeds free of any lien claims, for several reasons. Not only can mechanics liens potentially force double payment, but they also cloud the property title and can negatively impact bonding capacity and cash flow, all of which can actually prohibit successful and timely completion of the job. Because the desire to avoid lien claims is strong, and obtaining full protection via lien waivers can be difficult, other means to avoid lien exposure are sometimes used.
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Lien Waivers and Associated Difficulties
One way for the top-of-chain parties to manage lien exposure is by obtaining lien waivers from all of the lower-tiered parties. When the lien waiver document is used as designed, the process is fair and works to the benefit of all parties on the project. The lower-tier parties get paid and the top-tier parties get a waiver of the lower-tiered parties’ right to file a lien in return – everybody’s happy. The lien waiver functions as a receipt, and the project moves forward.
Because of this . . . strong desire of the top-of-chain parties to avoid liens in all circumstances, “no-lien” clauses or other provisions designed to eliminate the risk of liens by contract . . . are sometimes used. However, obtaining lien waivers from all parties can be a difficult undertaking, and this is especially true if there are some unknown parties on the project. If an owner or GC gets a lien waiver for a certain progress payment from a sub, that only protects against a potential lien for that payment from the particular sub. If the project is to be completely free of the risk of liens associated with a particular progress (or final) payment, lien waivers must be obtained from every party on the project – subs, sub-subs, suppliers, etc.
Since many construction projects have a large number of participants, getting all of the waivers can be challenging. Because of this, and the strong desire of the top-of-chain parties to avoid liens in all circumstances, “no-lien” clauses or other provisions designed to eliminate the risk of liens by contract without dependence on piece-meal lien waivers are sometimes used. This attempt to extinguish the right to file a lien preemptively is generally looked upon with disfavor by courts and legislatures and has been expressly outlawed by many states. The protection afforded by lien waivers, and due in part to the ongoing risk-shifting battle that occurs over construction payment and the risk of non-payment, it is an occasional but unfortunate occurrence that “no-lien” clauses, or other methods by which a right to file a lien is extinguished preemptively, are contained within contracts, or presented at another time prior to work being performed.
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No-Lien Clauses
In general, the attempt to extinguish the right to file a lien preemptively is looked upon with disfavor by courts and legislatures, and many states have disallowed their inclusion in contracts, and their enforcement, by statute or through court decisions.
A “no lien clause” is simply a clause within a construction contract (or a lien waiver document signed before the furnishing of work), whereby a party waives its right to later file a mechanics lien on the project. This means that the party agrees to perform the work without the ability to file a mechanics lien as security against potential nonpayment.
As noted above, as a general rule, these types of agreements are unenforceable. While United States law generally allows for the freedom of contract, sometimes rules are set in place to prohibit contracts that run afoul of public policy. Since you can’t contract against what the legislature and courts have determined to be the public good, in many states you can’t contract around the state’s interests in protecting construction participants against non-payment through the mechanics lien right.
Subordination of Mechanics Liens
Even in some states where the advance waiver of mechanics lien rights is disallowed, the subordination by contract of the mechanics lien to some other security interest is perfectly fine. In some cases, however, the inapplicability or unenforceability of a no-lien clause is not the end of the story.
Subordination of a mechanics lien relates to lien priority, and a lien’s priority is what may ultimately determine who gets paid in the event there’s not enough money to go around. While lien enforcement or foreclosure proceedings are not frequent, they do occur, and being at the end of the payment line can mean not getting paid – even if a valid lien was filed.
Subordination of a mechanics lien moves a lien from its place of higher priority and places it behind another interest in the property. Oftentimes, these subordination clauses are contained within lending agreements, so that the lenders can claim priority for their deed of trust over mechanics lien claims that may have otherwise had priority. The interest that was originally lower on the priority ladder now has the first bite at the apple, and the mechanics lien claimant can be left out of payment altogether. This can work as a back-door no-lien clause to some extent. If the party who would file a mechanics lien is allowed to effectively allow every other claim to have priority, the benefits of the lien are greatly reduced, if not eliminated.
It behooves construction parties to examine contracts for lien subordination clauses because even if a “no-lien” clause may not be enforceable, a lien subordination clause may be – and it can have the same ultimate result.