Maximize leverage with lien and security rightsIn 1791, Thomas Jefferson introduced the first mechanics lien law legislation and invented a public policy interest in the United States to always protect contractors, suppliers, and subcontractors from the risk of non-payment. As we’ve explored in previous posts, the ensuing 220 years brought epic battles between legislatures, courts, and parties about who should get paid when money gets tight on a construction project.

The single most important payment protection tool available to contractors and suppliers is the mechanics lien. General contractors and owners have tried to contractually offset this risk by including “pay when paid” clauses or “no lien rights” clauses within construction contracts. Frequently, therefore, the right to file a mechanics lien is directly at odds with the contractual waivers or payment provisions within a contract. Thomas Jefferson’s invented policy interest in protecting contractors and suppliers is pitted directly against America’s long-standing policy interest in the parties’ “freedom of contract.” How is this ever resolved?

Brian Loffredo, a business litigation attorney at Offit Kurman, published a blog article last week about this issue as it is settled under Maryland law: Did I waive My Right To File A Mechanic’s Lien in Maryland? The following quote from his article is a great set up for this article’s discussion:

Maryland recognizes the validity of “pay-when-paid” clauses in subcontracts…However, you can take solace in the fact that the Maryland legislature has enacted certain protections for subcontractors with respect to mechanic’s liens…[and] also states that a pay-when-paid clause does not abrogate or waive a subcontractor’s right to assert a mechanic’s lien…Therefore, even if you agreed to waive your rights in the subcontract, your mechanic’s lien rights against the property owner remain intact.

The friction between pay when paid provisions and mechanics lien rights in Maryland exists all across the country. In some states, courts have addressed the issue directly, but in other states the issue remains a legal gray area. Nevertheless, 220 years after their invention, mechanics lien rights still pack a punch. As the title promises, this article will explore whether the “pay when paid” clause can be made irrelevant with the proper use of lien rights.

Most States Do Not Allow Parties To Waive Their Lien Rights

Proper understanding of how mechanics lien rights can offset a “pay when paid” provision requires an examination of another contractual provision, what we refer to as “No Lien Clauses.” It is common for construction contracts to contain language prohibiting a party from filing a mechanics lien or bond claim. These clauses look something like this:

The contractor agrees to keep the property free and clear from liens, specifically agreeing to not to file a lien against the project under any circumstances and specifically waiving any and all rights under the law to file a lien claim in response to non-payment or a payment dispute.

It doesn’t matter how well this clause is written, it’s likely to be completely invalid. That’s because most states invalidate any such clauses as a matter of public policy, since it is the policy of the state to protect contractors and suppliers against non-payment by providing mechanics lien rights. Accordingly, since the state’s policy is to provide a mechanics lien right, that right cannot be taken away by contract.

While this is not exactly a “pay when paid” provision, little legal imagination is required to connect the consequences of a “pay when paid” or “pay if paid” provision to such a “no lien clause.” If a “pay when paid” provision results in a subcontractor or supplier not having the right to seek payment, isn’t that just another way of circumventing the public policy payment protection to subs and suppliers? For a broader discussion of this point, see this post: Can Owners Disguise No Lien Clauses?

Pay When Paid Clauses Are Ultimately Irrelevant Unless They Have More Restrictive “Pay If Paid” Language

Subcontractors and suppliers frequently get strong armed into unfair contracts, but if you take advantage of key laws, like mechanics lien laws, subcontractors and suppliers can almost always win.

The history of “pay when paid” clauses is quite interesting in itself, because it shows a healthy amount of skepticism by courts and legislatures across the United States about these provisions. In fact, through the years, courts have made it increasingly more difficult for owners or general contractors to use these provisions to offset the subcontractor’s or supplier’s right to payment.

At first, contract provisions simply provided that subcontractors and suppliers would get “paid when” the general contractor got paid. These “pay when paid” provisions, however, started failing in courts as a risk shifting provisions. Courts across the nation have almost unanimously concluded that these provisions are merely a “timing mechanism,” and that payment is required within some “reasonable time.”

In response to this the clause has gotten more sophisticated, and now reads as a “pay if paid” clause with owners and general contractors specifically enumerating in the contract that the clause is a “risk shifting” provision and that payment to the general contractor is a “condition precedent” to payment down the chain. These strict provisions have been invalidated by courts and legislatures across the country. California, for example, clearly outlaws these provisions as against public policy.

We wrote about this a few months ago in “Pay If Paid Provisions Highlight Epic Payment Battle Between GCs and Subcontractors,” echoing a conclusion by attorney Susan McGreevy in her May/June 2013 article on pay if paid clauses in CFMA’s Building Profits Magazine that policy favoring the subcontractor and supplier’s right to payment has a nationwide lead over pay-if-paid clauses.

While “pay if paid” clauses are increasingly declared invalid, there are many states that still allow them if the language is “clear and unambiguous.” Nevertheless, it is clear that a “pay when paid” has only a delaying effect on payment. Accordingly, “pay when paid” clauses are largely irrelevant to a subcontractor or supplier’s bottom line unless they have more restrictive “pay if paid” language.

Pay When Paid and Pay If Paid Clauses Are Ultimately Irrelevant If The Contractor or Supplier Files A Mechanics Lien

As discussed in the preceding section, pay if paid clauses can be valid or invalid based on a state’s interpretation, but how does these provisions affect a subcontractor or supplier’s right to file a mechanics lien? This question is largely unanswered across the country.

The right to file a mechanics lien is not a right borne under contract. Subcontractors and suppliers have a mechanics lien right as a matter of law in proportion to the value that their labor and/or materials contributes to a structure. In most cases, such as in California, the amount of the lien claim must be in direct proportion to this value, and is not guided or driven by the actual contract amount.

Therefore, if the contractor or supplier does not have a right to recover payment under a contract because of a payment provision therein, that does not necessarily mean the contractor or supplier has lost the right derived by the mechanics lien legal principle. The value was still contributed to the property, and the lien right is driven directly by that value.

Maryland Real Property Code § 9-113 provides that contracts cannot abolish or mitigate a mechanics lien right. Many states have this restriction in their statutes or jurisprudence. A pay-if-paid provision, if enforced to eliminate a mechanics lien right, would be a contractual clause that seeks to abolish or mitigate a mechanics lien right, and accordingly, is not valid for at least that purpose.

The Loffrendo article on Maryland law quoted at the start of this article points out the conflict presented by this issue:

[Y]ou probably have recognized an inconsistency here. Based on the above, it appears that a pay-when-paid clause would keep you from suing the general contractor, but would allow you to move forward against the owner of the property. If you reached this conclusion, you are correct. While the law protects mechanic’s lien claimants, it does not interfere with a subcontractor’s collections rights against the general contractor.

While this is not necessarily how the law will be interpreted in every state, there is a good argument for this interpretation of the law in almost every state that prohibits “no lien clauses.” There are few court cases across the country clarifying this particular issue, but as “pay if paid” clauses continue to gain popularity, the issue will certainly begin boiling across the country.

The Timing To File A Mechanics Lien Isn’t Affected By Your Pay When Paid Clause

We now have discussed two different payment provisions: pay when paid clauses, and pay if paid clauses.

In almost all circumstances, pay when paid clauses are merely a timing mechanism for payment and will not nullify a contractor’s or supplier’s ultimate right to payment. Similarly, in perhaps a majority of circumstances, even a pay if paid provision will not have a nullifying effect on a payment right. The question must then be addressed of what any of this means to the deadline to file a mechanics lien or bond claim?

These payment provisions control the timing of when you are entitled to payment, and it is reasonable or possible that the legal timing of when payment is due will be after the legal expiration of a mechanics lien or bond claim deadline. What can you do in this instance? Can you file a lien claim before you are legally owed money under the contract?

This was addressed a few years ago here in the article “Catch 22: Pay When Paid Clauses Do Not Extend The Lien Period.”

The important thing to remember is that these payment provisions may delay your legal rights to payment, but they do not delay or extend your lien periods. The lien period will open and shut as scheduled, and it is prudent (and legal) for you to file your claim even while you wait for payment to get triggered by the clauses. You should almost always file your mechanics lien or bond claim before the deadline, regardless of the payment provision’s effect.

Conclusion: It’s Complicated, But Subcontractors and Suppliers Have Great Arguments

play-cards-right-with-lien-rights
If you protect your lien rights and play your cards right, you’ll almost always be able to get paid for your materials and labor.

In this article, I’m a bit bullish on the mechanics lien rights over restrictive payment provisions. There are some specialized instances when the language of the lien statute will not enable you to offset a strict payment provision. This happened in an Indiana case last year, which we reviewed in “Can Pay When Paid Clauses Destroy Your Mechanics Lien or Bond Claim Rights.” In fact, to get a different and more conservative perspective on the issue, read that article.

Notwithstanding this conclusory disclaimer, I will state that these payment provisions are always strictly construed by the courts. Further, the right to file a mechanics lien is a broad right with a long public policy history. Combining these two big picture legal realities, the stars must align for the owner and general contractor to offset a lien right with strict and unfair contractual language.

While there are some instances where a subcontractor or supplier might get left high and dry, these instances should be in the minority of cases. If you protect your lien rights and play your cards right, you’ll almost always be able to get paid for your materials and labor.