At the Construction Financial Management Association’s Annual Conference in Las Vegas, we encountered a very large general contracting outfit who has a lot of financial risk shifting procedures in place. They employ strict subcontractor prequalification requirements and dictate the contract terms to insulate their company from financial risk. While pushing more and more financial risk off their back and doing business completely on their own terms, they tout that they are “all about relationships.”
And when it comes to mechanics lien rights and exposure they have an interesting, but perhaps illegal, policy. They tell subcontractors and vendors that they don’t do business with companies who send preliminary notices.
Is this legal? And is the general contractor protecting themselves, or opening themselves up to more uncertain financial risk?
Is A GC’s Demand to Subcontractors To NOT Send Preliminary Notices Actually An Illegal “No Liens Clause?”
The mechanics lien and bond claim laws exist to protect subcontractors and suppliers against financial risk shifting practices by the top of chain parties, such as the general contractor, owners, and lenders. These laws are primarily in place because of the problematic position that lower tiered parties find themselves. The top of the chain dictates the terms of the contract and controls the flow of cash. Liens and security rights are a legal counter balance to this reality.
Obviously, the top of the contracting chain doesn’t like liens and security rights very much. They started installing “no lien clauses” in their contracts (Where You Cannot Waive Lien Rights Before Payment). They employ contingent payment provisions like pay-when-paid and pay-if-paid clauses, and a number of other financial risk shifting mechanisms.
The general contractor uses the power of its position as business provider to influence subcontractors into “giving up” their lien rights by electing to not send a preliminary notice. I ask, however, isn’t this the same thing as including an illegal “No Liens Clause” in the subcontract? Legislatures, understanding the nature and purpose of the lien protections, continue to pass law after law to nullify these “top of the chain” practices. They invalidate pay if paid clauses as unenforceable, and they invalidate no lien clauses as void and unenforceable.
As this referenced general contractor’s practice indicates, however, creativity is used to brainstorm additional ways to circumvent a subcontractor’s mechanics lien rights. In this example, the general contractor uses the power of its position as business provider to influence subcontractors into “giving up” their lien rights by electing to not send a preliminary notice.
I ask, however, isn’t this the same thing as including a “No Liens Clause” in the subcontract?
A “No Liens Clause” is a provision in a contract requiring a subcontractor to waive their lien rights before they receive payment. A policy to not do business with subcontractors who send preliminary notices is simply the same thing, just without an accompanying contract provision. It is a requirement that subcontractors waive their lien rights before they receive payment.
General Contractor / Subcontractor Relationship Are Abusive When Lien Rights Are Attacked
Everyone has heard the saying “who you are speaks so loudly, I can’t hear what you’re saying.” This is a relevant phrase when thinking about the definition of “relationship” in the context of the construction industry, and specifically the business relationships between general contractors and subcontractors.
At the CFMA conference, I attend a “Prequalification” panel and they commented repeatedly about how important “relationships” are in selecting and pre-qualifying subcontractors. However, when you peel back the onion on these companies and their policies, what they are doing is speaking pretty loudly. They require joint checks, they flag subcontractors when they call asking for payment after waiting 60 days post-billing, they demand customers not send preliminary notices, and they stuff their contract with contingent payment clauses and other financial risk shifting clauses.
When the subcontractors are stripped of their lien rights, this leaves those subcontractors naked and abused in the event of a problem. General contractors who don’t care about this, don’t care about their subcontractors. General contractors scream that relationships are important, but really, it’s relationships on their terms. It’s very easy, from their perspective, to have a quality relationship with the subcontractor on such terms. In reality, however, the subcontractor is likely feeling a bit abused. They accommodate because of the general contractor’s influence and contracting power.
Notwithstanding the legality of demanding subcontractors give up their lien rights…one should wonder what type of relationships can be build when such a demand is made.
General contractors respond to this type of talk that they “pay their subs fairly,” and therefore, they don’t need to be regulated by security rights. However, even the most well-meaning general contractors are going to encounter problems, and these problems are going to affect their subcontractors. When the subcontractors are stripped of their lien rights, this leaves those subcontractors naked and abused in the event of a problem. General contractors who don’t care about this, don’t care about their subcontractors.
A lot can go wrong with projects. Sometimes, it’s the general contractor’s fault, sometimes it’s a subcontractor’s fault, and sometimes it’s everyone’s or no one’s fault. If a subcontractor was forced to abandon its lien rights and the project has problems, that subcontractor is going to be without any remedy whatsoever, all because the general contractor selfishly wanted to insulate itself from the risk of non-payment.
The general contractor didn’t trust the subcontractor, and so it demanded that the subcontractor appear on the project on its complete terms. Unprotected and vulnerable.
General Contractor May Have More Risk Than It Thinks When It Suffocates Lien Rights
If I’m the attorney representing a subcontractor who ran into problems with this unnamed general contractor, I’m going to lick my chops.
The Lien May Get Filed Anyway…And The GC, Owner, and Lender Didn’t See It Coming
The first thing I’m going to do is file a mechanics lien. Yes, the subcontractor may have technically waived its rights by not sending preliminary notice, but I’m going to file the lien and claim that the practice of refusing preliminary notices is against public policy, and accordingly, exempts the subcontractor from the preliminary notice requirement.
The problem with this argument is that the owner and lender would be adversely affected by the general contractor’s fraudulent or illegal policy, but those problems will be tempered by the relationship between the general contractor and these other parties (i.e. the lenders and owners). Depending on the unity of that relationship, the preliminary notice exception argument would get stronger.
Accordingly, while the general contractor’s policy is an attempt to avoid their mechanics lien exposure, it may turn out that they do not avoid the exposure at all. To the contrary, they are going to be liened out of left field, without a preliminary notice being provided. The lender and the owner may or may not know about the general contractor’s practice, but unfortunately, they are going to be negatively impacted by it.
The GC Will Be Sued For Unfair Trade Practices And Fraud
The second thing I’m going to do is sue the general contractor for violating the law in requiring that the subcontractor void and give away their mechanics lien rights in contrast to the law’s prohibition against the same. Of course, I understand why the general contractor selfishly wants this policy. However, the policy is illegal. It is in explicit violation of the mechanics lien laws and its long-standing legislative purposes.
The suit will seek damages associated with the potential loss of lien rights. But furthermore, it will seek damages under the state and possibly federal Unfair Trade Practices Act and similar provisions.
Demanding that subcontractors give up their lien rights by electing to not send a preliminary notice is a bad, bad policy employed by general contractors. It is an abuse of their position and it’s a violation of most states’ laws. The general contractors are putting themselves at risk by embracing a policy like this, but more importantly for subcontractors, this is a clear indication of a general contractor who values abusive relationships.
When the general contractor says they care about “relationships” and that you don’t need lien rights because “they pay their subs fairly,” look right though this. Prequalify them. They are abusers, and they should be avoided.