Funds and Financial RiskGenerally, mechanics liens provide strong protection to parties in the construction industry because they encumber the actual property being improved by the lien claimant’s furnishing of labor and/or material. The security and leverage provided by the ability to enforce a claim for payment by foreclosing on the property itself is really what gives the mechanics lien its teeth.

A mechanics lien attached to a leasehold interest is nowhere near as powerful as a mechanics lien attached to the underlying property
In some states, the attachment to the underlying property may be modified or destroyed based on the party originally contracting for the improvement. If the improvement was initiated by a tenant, or another party with less than a “fee simple” interest in the property, a subsequently filed mechanics lien may only attach to the interest of the party who contracted for the improvement. That is, in certain circumstances, a mechanics lien filed pursuant to a tenant improvement, may only attach to the tenant’s leasehold interest in the property. More discussion of the possible outcomes of filing a lien on tenant improvements can be found here.

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What Good Is a Lien on a “Leasehold Interest”?

One current possibility for mechanics lien filed against tenant improvements is that the lien may attach to the interest of the party who originated the contract for improvement. Thus, if a tenant contracted to improve the property, a subsequent mechanics lien would attach to the tenant’s interest – his/her lease.

Some attorneys have called the protection afforded by such liens “illusory” for two particular reasons: 1) most leases have a no-lien clause that allows the lease to be terminated if a lien is filed – and if the lease is terminated the lien claimant’s rights against the “leasehold interest” are extinguished; and 2) if a claim against a “leasehold interest” is successfully ‘foreclosed’ it generally requires the acceptance of both the lease benefits and the obligations, i.e. the requirement to pay rent.

In some cases, the pressure of potentially losing the lease is enough to prompt payment from the tenant, especially in commercial situations where a large company is the tenant.
I agree that in many cases, the above is true – and certainly a lien against a leasehold interest is far inferior to a lien attached to the underlying property – but a lien on the leasehold interest is not worthless, particularly prior to foreclosure. In some cases, the pressure of potentially losing the lease is enough to prompt payment from the tenant, especially in commercial situations where a large company is the tenant.

To be sure, however, a mechanics lien attached to a leasehold interest is nowhere near as powerful as a mechanics lien attached to the underlying property. And, for smaller leases, or easily re-lease-able property, the protection of a lien against the leasehold interest may be illusory, for all practical purposes.

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North Carolina May Provide More Protection To Lien Claimants On Tenant Improvements

Currently, North Carolina allows mechanics liens to be filed against leasehold interests as explained above. So, when a property improvement is initiated by a tenant parties on that construction project may file a lien to secure payment, but the lien attaches to the “leasehold interest” in the property, not the underlying property itself.

[does] the unjust result of parties doing work and remaining uncompensated (despite following all statutorily mandated provisions to obtain a valid mechanics lien) outweigh the exposure of the property owner to liability for work for which he/she did not explicitly contract[?]
As mentioned, a mechanics lien limited in this manner does not provide the same protection as a traditional mechanics lien attached to the underlying property. Discussion is now occurring in North Carolina to extend the protection of a mechanics lien pursuant to a tenant improvement to the fee simple interest of the property owner, so that the underlying property would become security on tenant improvement projects as well as owner-initiated projects.

The discussion was prompted, at least in part, by an acknowledgement by a North Carolina court that the law, as written, could result in an “unfair result” in which a party could perform the work and still not get paid despite complying with all requirements and filing a valid mechanics lien. The question for North Carolina to consider is whether the unjust result of parties doing work and remaining uncompensated (despite following all statutorily mandated provisions to obtain a valid mechanics lien) outweighs the exposure of the property owner to liability for work for which he/she did not explicitly contract.

Since the property owner ultimately reaps the benefit of the tenant improvement (it will stay with and increase the value of the underlying property), it seems generally more fair to extend the protections of the mechanics lien in tenant improvement situations, but there is still a lingering distaste to making a property owner pay for something he/she may not have approved.

The Fairest Solution?

In order to be as fair as possible, I would recommend extending lien rights for tenant improvements against the underlying interest of the owner when the owner knew or should have known of the improvements. If the owner had knowledge of the improvements, or should have had knowledge of the improvements, and allowed the improvement to continue, it seems that the owner by availing him/herself of the benefits of the improvement should subject him/herself to the potential liability for them, as well.

Matt Bouchard, a North Carolina lawyer has created an informal poll though which you can express your opinion on the matter, here. What do you think North Carolina should do?

Whatever North Carolina decides, The Construction Payment Blog will provide information and commentary.

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North Carolina Potentially Extending Lien Rights for Tenant Improvements
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North Carolina Potentially Extending Lien Rights for Tenant Improvements
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Currently, mechanics liens filed pursuant to tenant improvements in North Carolina only attach to the tenant's "leasehold interest". This may change.
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