Construction projects are everywhere these days, and with all that added activity comes all kinds of issues concerning payment disputes with the contractors doing the work.  One of the most common legal questions we get from investors doing fix & flips is how to get rid of mechanics liens on the property.

For those dealing with renovations, it is critical that you understand mechanics liens, and how to avoid them. A bit of documentation up front can save you a ton of money, aggravation, and marketing time down the road.

What are Mechanics Liens?

Mechanics liens are liens filed by contractors, material providers, suppliers, subcontractors, and others that furnish material or labor in connection with the improvement of a property. Once properly filed, a mechanics lien will remain a lien on the property until  paid off or until it expires.  The filed lien provides tremendous leverage for a contractor because the lien makes it difficult to sell or mortgage the property until the lien is released. Mechanics lien holders do not have to wait to get paid upon sale of the property. The mechanics lien law gives the lien holder the power to foreclose on the lien and get paid through the proceeds of a sheriff’s sale.  In other words, it’s an extremely powerful tool for collection and flippers need to avoid them.

Who Can File?

The contractor you hire, the contractor’s subcontractors, and the contractor’s suppliers, are all potential lien claimants that can place a mechanics lien on your property for nonpayment.

What’s the Process?

The mechanics lien statute in Colorado has a number of strict requirements that a lien holder must follow in order to enforce a lien. The basic steps are these:

  1. Claimant serves a Notice of Intent to file a lien.
  2. Claimant records a Statement of Lien
  3. Claimant brings a foreclosure lawsuit to enforce the lien.

With each step there are particular criteria and time deadlines that must be followed. For instance, the Notice of Intent and Statement of Lien must include correct information about the legal description, owner, amount of lien, etc. Also, if the lien holder misses a deadline to file a Notice, Lien, or lawsuit to enforce the lien, the lien will become unenforceable.

What are the deadlines?

Lien claimants can’t just wait around forever to file a lien. In private construction projects, the lien claimant must file a Statement of Lien (or an extension to file) within 4 months that the work/material is furnished by the claimant. However, this time frame may be reduced to 2 months when the property is a residential property.

If a lien is timely recorded, the lien holder can bring a lawsuit to foreclose on the lien within 6 months of the last work completed.

How Do You Defend a Lien (or make it go away)?

Short of a settlement agreement, the most common defenses to mechanics liens revolve around the lien holder failing to follow the rigid procedures under the statute. If the claimant misses a deadline, or fails to serve or record the notice or the lien statement properly or timely, the claimant’s  lien will be invalid. At that point you will still have to convince the claimant — or its attorney — that the lien is invalid.

Colorado homeowners may also be entitled to the homeowner defense from liens filed by subcontractors. In Colorado there is a nifty statute that protects homeowners from liens from subcontractors when they have paid the general contractor.  If the homeowner pays the general, and the general fails to pay the subs, the subs will not be able to enforce a mechanics lien.  General contractors that fail to pay the subs can also be held liable under the trust fund statute and criminally prosecuted.

Preventing Liens in the First Place:

In most cases mechanic’s liens can be avoided by obtaining properly executed lien waivers from the contractor.  Each time you disburse a payment to a contractor or supplier you should have them sign a lien waiver in exchange for the check.  The lien waiver should cover all work done or supplies furnished up to the date the lien waiver is signed.  Here is a general lien waiver form for ongoing work.  In addition to the lien waivers, you should also place a restrictive endorsement on your checks.  You may also consider including a lien waiver provision in your construction contract.

Getting to Closing When the Property has a Lien:

Mechanics liens are a big headache when it comes to selling because the title company will require that the lien be paid in full.  It doesn’t do a lot of good to show the title company how bad the contractor was, and that the contractor doesn’t deserve the money.  The title company can’t get in the middle of deciding whether the lien is proper or not.  You’re going to have to deal with the lien.

Most contractors file liens because the want to force payment when you sell the home, not because they intend to bring a foreclosure action.  Since you must normally pay off the lien in order to pass clear title to your buyer, the contractor has some serious leverage.  However, there is a way around full payment of the lien.  The most common solution is creating a special escrow authorized by Colorado statute.  This involves placing in escrow with the title company funds equal to one and one half times the lien amount.  This escrow is held until the lien statement expires, or until you and the claimant reach some settlement.  If the claimant brings an action to enforce the lien before it expires, the escrow funds are transferred to the court through a special process that requires the clerk release the lien on the property.  The parties then fight over the money in court.  If the lien claimant does not bring any enforcement action, the title company will release escrow funds to the seller after the lien statement expires.  If you can afford the escrow, the process is an excellent way to deal with the lien.

Being proactive with appropriate contracts, good disbursement methods, and the use of lien releases are the best ways to avoid a lien, but don’t just roll over if one gets filed. Talk to us about how we may be able to close by holding funds in escrow.

Greg Parham, Attorney and Operations Manager for First Alliance Title