SuretyBonds.com contributor posts provide external expertise to help small businesses and other professionals succeed. This post features insights from Justin Gitelman, content coordinator at Levelset.
How can construction contractors and material suppliers ensure that they get paid by their customers? Mechanics liens are one tool that companies can use to help ensure that they are paid. The right to file a lien is protected by state statute in all 50 states and the District of Columbia, as well as in many countries around the world.
According to a survey Levelset conducted in partnership with TSheets by Quickbooks, 49% of contractors are not paid on time according to their contracts. Contractors and material suppliers need to be aware of their rights and their options when it comes to collecting payment from their customers.
What Mechanics Liens Can Do
A mechanics lien is a legal instrument that serves to protect contractors and material suppliers from nonpayment by their customers on privately owned projects. All licensed contractors and suppliers who provide materials, equipment, or labor for a construction project generally have the right to use a mechanics lien to enforce their right to payment.
Mechanics lien rights and responsibilities are set by state statute. States have different requirements and rules that regulate the right to payment and the use of liens. Deadlines and documentation requirements are different in each state. Before you begin work in a new state, it’s recommended that you review the mechanics lien laws so you know what to expect. If you don’t follow the law, you could lose your right to file a lien.
If a customer doesn’t pay you for the work or materials you provided, you can record a mechanics lien at the county clerk’s office. The lien attaches to the deed for the property and will show up when anyone does title research on the property.
It’s extremely difficult to sell or refinance the property until the lien is released, which only happens after payment has been received. If the property owner doesn’t pay the debt within the state’s deadline, the contractor can file a lawsuit to foreclose on the lien.
Once the lien has been foreclosed by a judge, the owner is forced to sell the property and use the proceeds to pay the debt.
How Liens and Bonds Work Together
A mechanics lien uses the property itself as security for the payment, but a contractor’s lien rights can also be affected by certain types of bonds.
Because liens can’t be filed on publicly owned property, payment bonds are used to protect contractor and supplier payment rights on government construction projects. Payment protection is provided by the surety company, not the project owner. They’re not only available on public projects, though; payment bonds are used on most public and some private projects to protect subcontractors and suppliers from nonpayment.
The bond is purchased by a contractor and ensures that payment will be made to their lower-tier subcontractors and suppliers. If the lower-tier parties are not paid, they can file a claim with the surety company and receive payment from them. The contractor who purchased the bond then has to pay the surety company back for the debt it covered.
Bonds are held by the surety company, which is responsible for paying a subcontractor or supplier if there is a problem with payment. Recording a lien and filing a court case isn’t required. The process of filing a bond claim is fairly simple, and parties can expect to be paid promptly after the surety investigates.
Understandably, property owners want to avoid liens on their property. They can protect their property against payment claims before a project starts by having the general contractor post a payment bond. But what happens if a subcontractor has already filed a lien?
In this case, the general contractor can post a lien bond to replace the lien, known as “bonding off” a lien. This essentially removes the lien from the property and requires the unpaid contractor or supplier to file a bond claim instead. The debt is then paid by the surety company, and the property owner pays the surety company back.
In most states, contractors must hold certain bonds as part of their license requirements in each state. If their bond coverage lapses, they can lose their license in the middle of a project. In some states, this could cause them to lose their lien rights — or any right to collect payment at all.
In some states, contractors are required to be licensed in order to file a lien on a property. This is one reason why it’s important for contractors to be licensed in the states they work in. There are a few states that will allow unlicensed contractors to file a lien for work they’ve performed. In others, like Louisiana, contractors are entitled only to the “minimum value” of their work if they aren’t licensed.
In a few states, having a contractor’s license is required in order to recover payment in any way, including collections or lawsuits. For example, in California and Washington, contractors must be licensed to file a lien or a lawsuit for collection. If an unlicensed contractor provided $1 million worth of work and a party refused to pay the contractor, that contractor would be without a remedy to collect the payment.
Licensing protects customers from unscrupulous contractors who don’t have the proper protections, like insurance and bonding. Some states require contractors to take classes that are meant to improve their chances of business success or tests to assess their knowledge of business topics and trades. It pays to get licensed in every state you perform work in to protect yourself and your customers.
Liens and Bonds Protect Payments
Mechanics liens provide contractors with a powerful remedy to collect payment on work they’ve performed. Because construction work can’t be returned or removed due to nonpayment, contractors and suppliers have been given the ability to attach to a property’s deed.
Often, the filing of a lien, or the threat of one, is all it takes to get the owner to make payment. But a contractor’s lien rights can be affected by bonds and bonding requirements. Contractors need to know the laws and requirements so they can protect their own payments on every project.