A construction contract is the backbone of any project. They lay out all of the rights, obligations, and remedies between the parties to a contract. If any of these aren’t met or upheld, the general rule is that only parties to a contract can legally enforce the terms of the contract. That’s because the have privity of contract with one another. In the construction industry, there are contractual and statutory exceptions to this doctrine. The most powerful one being a mechanics lien. This article will explain what privity of contract is, and how it affects a construction party’s payment rights.
What does privity of contract mean?
Privity of contract is a legal concept that governs who is allowed to enforce a contract between two parties. The privity of contract doctrine is a relatively simple concept with enormous implications. In essence, it describes the relationship between the parties to a contract. This common law doctrine states that contractual rights and obligations can only be imposed against those who signed it. When a party signs a contract, it is legally bound by those terms; that’s the whole point of a contract. However, someone who isn’t privy to a contract cannot legally enforce it.
When a party to a contract wants to enforce those terms, they can typically do so only if they have contractual privity with the other party (i.e. the contracting party). This doctrine of contract law applies to both written and oral contracts.
Privity in construction: The power of mechanics liens
The concept of privity of contract is one of the main reasons why a mechanics lien is such a powerful tool. Given the complex, often obscure structure of the payment chain on construction projects, state legislatures have provided mechanics liens as an exception to privity help protect payments of lower-tiered project participants.
Liens are an exception to the doctrine of privity of contract
Let’s explain this using a quick example:
Imagine you are a sub-subcontractor doing electrical work. You have a contract with a subcontractor, who has a contract with the GC, who is contracted with the property owner. You finish the last portion of your scope of work and submit an invoice for final payment, but payment never comes.
Without mechanics lien rights, your legal options for recovering payment are limited to claims against the subcontractor who hired you (i.e. the person with whom you have privity of contract). If they don’t have lien rights, a construction professional can typically only pursue payment under contract law claims such as breach of contract, unjust enrichment, and prompt payment laws.
A mechanics lien can bypass this doctrine. This allows a subcontractor to leapfrog the GC, and go straight to the source of the project funds: the owner. (Or, more accurately, the real property of the owner.) This provides the contractor with some powerful leverage. When you file a lien, the owner will be forced to out the pressure on the party who hired you to resolve the payment issue before it affects their property.
How privity affects your lien requirements
If you’ve ever looked at your state mechanics lien statutes, they can tend to get overwhelming. There are multiple notice and deadline requirements that you must strictly comply with. There are varying requirements depending on your role on the project. This is where privity of contract comes into play.
For instance, in California, nearly every project participant needs to provide a preliminary notice in order to secure their lien rights. One major exception to this is if you are a general or prime contractor, meaning you have privity of contract with the property owner. The owner already knows who the GC is, and the have contract claims available to them if the somehow lose their lien rights. A GC is required to provide a preliminary notice if there’s a lender on the project.
Why? Because the lender is the source of money on the project, and doesn’t have a contract with the GC. A preliminary notice ensures they are aware of the parties that need to be paid.
Who you have contractual privity with on a construction project is a major determining factor when evaluating your requirements to secure, perfect, and enforce your lien rights.
How privity of contract affects your lien priority
Priority is another aspect to mechanics lien law that could potentially be affected by privity of contract. Lien priority refers to who gets paid first if a property ends up being foreclosed. Most states follow the general rule that, no matter when filed, the mechanics lien will related back to the commencement of the project. However, this isn’t always the case. There are some states and circumstances where your priority will be affected by who you have privity of contract with.
In Florida for example, if a Notice of Commencement was filed on the project, all mechanics liens filed on the project will relate back to that date. So how are the funds distributed among those lienholders in a foreclosure action? Under §713.06(4)(a), the owner or court shall pay or allow such liens in the following order:
- Liens of all laborers
- Liens of all persons other than the contract
- Lien of the contractor
Again, the underlying rationale for this is likely due to the fact that a direct contractor will have other legal avenues of recovery since they have privity of contract with the property owner.
Other common exceptions to privity of contract
Mechanics liens aren’t the construction industry’s only exception to privity of contract. There are numerous others that allow for claims to be brought against those you didn’t contract directly with. Here are a few other notable exceptions that are commonly applied when it comes to construction payment.
Assignment of rights
This can refer to either assignment of claims or assignment of benefits. These are both ways that privity of contract can be circumvented. An assignment of claims is a contractual provision that transfers certain right to enforce the terms of a contract to a third party beneficiary. For more on assignment of claims see: Indiana City Sues Sub-consultant Without Privity of Contract.
Similarly, there is also a common practice in the restoration industry known as assignment of benefits. This allows a third party (such as a contractor) the authority to file a claim, decide repairs, and collect insurance payments on behalf of the property owner.
When you look at some state mechanics lien statutes, many will refer to an “owner or an owner’s agent.” Agency law allows an individual to confer rights onto another person to act on their behalf. This means that if you wanted to file a claim for breach of contract with a property owner, under a contract signed by their agent, this is still allowed. This is because the individual is acting on behalf of the property owner.
Construction trust fund statutes
Trust fund statutes provide yet another statutory exception to privity of contract. These construction trust fund statutes are meant to protect all project participants from the misapplication or misappropriation of project funds. They do so by expanding liability well beyond the four corners of a contract.
We’ll use the Texas Construction Trust Fund Act as an example. Under this law, anyone who has control or direction of project funds are deemed to be trustees for the benefit of any and all subcontractors or suppliers that the funds are meant to pay. Any beneficiary who goes unpaid due to the misappropriation of funds can have a claim agains the trustee who misused said funds.
There are two other legal doctrines that allow for recovery without privity of contract. These interrelated theories are known as unjust enrichment and quantum meruit. Unjust enrichment allows a party to recover payment when a someone retains a benefit, but there is no contractual duty to pay. This doctrine allows a claimant to recover the reasonable value of the benefit received, because allowing the party to retain the benefit without pay would be inequitable.
On the other hand, the doctrine of quantum meruit, is when the law determines that there was a “contract implied in fact.” They impose a “quasi-contract” when a party receives a benefit, and there is a reasonable expectation that the services or benefit was going to be paid by the party receiving the benefit.
The Bottom Line: Privity is important, but it isn’t everything
According to most laws, who you have a contract with will determine your rights when it comes to enforcing it. In construction, however, there are a number of exceptions that do not require privity of contract in order to recover payment from the party who controls the purse strings.
Because of this exception, mechanics lien laws are some of the most powerful available, particularly to sub-tier parties who do not have a contract with the property owner. Anyone who works in the construction industry would do well to protect their lien rights on every project.