In These Desperate Times, Be Sure that Payments on Your Construction Project are Received by the Proper Parties
By: JOSEPH G. SPRINGER
March 2009
“Desperate times call for desperate measures.”
These are desperate times for some in the construction industry. General contractors, subcontractors, material suppliers, and others in the construction industry are facing financial difficulties. Out of desperation, such persons may take money from one job and use it to pay bills on another. Even if funds are not purposefully diverted from one project to another, a judgment creditor may attempt to garnish funds from one project because of a debt owing on another project.
If you are the person paying the money, why should you care if creditors of the person receiving the money get paid? Because of mechanic’s liens. Under Minnesota’s mechanic’s lien law, a mechanic’s lien may be filed by anyone who has not received payment for labor or materials provided for an improvement to real property, even if the owner has fully paid its general contractor, or even if the general contractor has paid its first tier subcontractors. In this situation, there is a risk of having to pay twice for the same improvement. There are some exceptions to this possible double liability, including for improvements to residential property where an owner pays the general contractor before receiving pre-lien notices. But as a general proposition, participants of all tiers, whether an owner, general contractor, or subcontractor, should take steps to ensure that lower tiers receive payment in order to avoid the possible risk of liens and double payment. This article explains how to ensure that those deserving payment actually receive payment.
As with many things in life, taking proper steps at the outset helps to avoid potential problems later. Owners should require in their contract that the general contractor identify subcontractors and material suppliers who will contribute to the project. General contractors should require the same from their subcontractors and suppliers. This way the party making a payment, whether this is the owner, general contractor, or subcontractor, has a list of persons from whom to receive a lien waiver for each payment, and perhaps most importantly, from whom to receive a full and final lien waiver upon final payment for the project. It is important for the party making the payment to receive lien waivers not only from the person receiving the payment, but also from subcontractors and material suppliers of the person receiving the payment. Even if you receive a full and final lien waiver from the party to whom you are making payment, subcontractors and material suppliers to the party receiving payment can file a mechanic’s lien if they are not paid. In desperate times, anyone making a payment on a construction project needs to be diligent about receiving lien waivers from all down-stream contributors.
Payment and Performance Bonds are also a tool to avoid mechanic’s liens. A Payment and Performance Bond is a bond that is issued by a surety, a presumably well-capitalized and solvent company like an insurance company, on behalf of the principal, which is either a general contractor or a subcontractor. If the bonded principal defaults in either payment or performance of any obligations, the surety company steps in to remedy the default. If the default is the failure to make payment or the filing of mechanic’s liens, the surety company would make the payment and satisfy the liens. If the default is a failure to perform, such as by going out of business or otherwise failing to complete the project, the surety company usually hires another contractor to complete the work.
Payment and Performance Bonds have some downsides and are not always a perfect remedy. One reason is the cost—depending upon the cost of the project and the principal’s history and credit worthiness, a Payment and Performance Bond will generally cost between one-half percent (0.5%) and one and one-half percent (1.5%) of the cost of the contract. This cost is generally passed on to the owner. Additionally, a failure to pay or perform is not always clear on a construction project. In such case, an owner may need to sue the surety company to obtain a court determination of whether the principal is responsible for the payment or performance default. Even if the owner has to file suit, at least the surety company is a presumably solvent defendant.
The above options largely address the situation where someone may be diverting funds, but what if the party paying money for a construction project is served with a garnishment? A garnishment summons is just like a summons for a criminal or civil lawsuit and imposes legal obligations upon the recipient. A garnishment is an order to disclose and hold any money or other property that is due and owing to the judgment debtor. A garnishment is usually followed by a levy, which is an order to turn over the money. A general contractor or subcontractor that has had problems on a project may receive a judgment against them. The holder of the judgment, called a judgment creditor, has the right to seek to garnish or levy against anyone owing money to the judgment debtor. If you owe someone money for a construction project and receive a garnishment and levy, are you obligated to turn over the money and then risk the imposition of mechanic’s liens on your property or project? Not necessarily. Under the garnishment statute, Minn. Stat. § 571.73, only money that is “due” and “owing” to the judgment debtor is attachable by garnishment. The same statute provides that money is not subject to attachment by garnishment unless the money is “due absolutely or does not depend upon any contingency.” Most well-drafted construction contracts require, or at least give the person making payment the option to require, receipt of mechanic’s lien waivers in exchange for payment. Even in the absence of a well-drafted contract, Minn. Stat. § 514.07 provides that an owner may withhold from the owner’s contractor as much of the contract price as may be necessary to satisfy any liens arising out of the improvement. Therefore, until lien waivers are provided, the payment is not “due” and “owing” and attachable by garnishment.
A section of the mechanic’s liens statute also provides a tool to avoid liens if a judgment creditor attempts to garnish funds from a construction project. Minn. Stat. § 514.02 provides that proceeds of payments received by the person contributing to an improvement to real estate “shall be held in trust by that person for the benefit of those who furnished” the labor and materials, and that “proceeds of the payment are not subject to garnishment, execution, levy, or attachment.” This statute provides a defense to general contractors or subcontractors who run into problems on one project from those problems spilling over onto another project.
Contractors have good reason to present liens from being asserted on one project because money has been diverted to another project. Section 514.02 of the mechanic’s lien statute further provides that a person who fails to use the money paid to that person for a construction project to satisfy claims of its subcontractors or material suppliers on that project shall be guilty of a theft of the proceeds. Depending upon the amount at issue, the criminal theft statute, Minn. Stat. § 609.52, provides for imprisonment of up to 20 years, a fine of up to $100,000 or both. The mechanic’s lien statute further provides for possible personal liability for the person committing the theft.
Section 514.02 of the mechanic’s lien statute expressly provides that it does not “require money to be placed in a separate account and not commingled with other money of the person receiving payment.” Despite this, a contractor or subcontractor who is facing problems on one project may want to establish separate accounts or at least ensure that payments and expenses for each project is separately tracked in order to avoid potential personal or criminal liability for the failure to use payments on one project from being diverted to other projects. To alter the famous phrase, desperate times call for proactive and protective measures, for all participants in a construction project.
Takeaway
Participants of all tiers in a construction project, whether an owner, general contractor, or subcontractor, should take steps to ensure that lower tier participants receive payment in order to avoid the possible risk of mechanics liens and double payment.