In the current financial climate, many buyers of newly constructed, or recently improved, homes and buildings are having the joy of ownership replaced by visions of great financial loss unrelated to their own actions or financial situation. They have paid the full purchase price for their new properties but find strangers knocking at their doors threatening to take their properties away unless paid thousands of dollars. What surprises and shocks buyers is learning that the strangers have the legal right to make the demands and, if not paid, to sell the properties right out from under the buyers. How can this happen?
The Preferred Rights of Contractors
Some might think that the right of the stranger at the door is something that has resulted from an oversight by the General Assembly, poorly considered court decisions, or bureaucratic bumbling. They would be wrong. In fact, the right of the stranger is written into the North Carolina Constitution which requires the General Assembly to give to “mechanics and laborers an adequate lien on the subject-matter of their labor.”
In response to this constitutional mandate, the North Carolina General Assembly has enacted statutes which provide for an “adequate lien” not only to “mechanics and laborers,” but also to “any person who performs or furnishes labor or professional design or surveying services or furnishes materials or furnishes rental equipment pursuant to a contract…with the owner of real property for the making of an improvement thereon.” These persons have a right to file a claim of lien on the real property to secure payment of all debts owing for labor done, services provided, or materials furnished.
General Contractors and Subcontractors
Under North Carolina law, it’s important to distinguish between contractors of different “tiers.” When a property owner decides to improve real property by, for example, constructing a building, the owner usually hires a single contractor to “get the job done.” A contractor who deals directly with the owner usually is called a “general contractor,” and will be referred to in this article as the “General.” The General, in turn, will hire other contractors, called subcontractors (“Subcontractors”) to, for example, clear the land and construct the building. Both of these Subcontractors are called “First-Tier Subcontractors” because they contract directly with the General, not the property owner. The First-Tier Subcontractor, in turn, may hire other Subcontractors to furnish labor or materials to the project. For example, the First-Tier Subcontractor may purchase materials from a lumber supplier or hire an insulation contractor to insulate the building. These Subcontractors and suppliers are called “Second-Tier Subcontractors” because they contract directly with the First-Tier Subcontractor. The same pattern continues with each subsequent Subcontractor.
In this Part One, we will focus on the basics of the laws giving Generals and Subcontractors preferred liens on real property and which are causing considerable problems in this time of recession immediately following an unprecedented boom in construction. Next week’s installment will present a specific example of how the laws affect buyers and will offer some potential safeguards buyers can take to protect their interest in their property.
What is a Lien on Real Property?
As a general rule, in North Carolina, once the General has furnished labor or materials, or has caused a Subcontractor to furnish labor or materials, in relation to construction on a parcel of real property, the General has the right to place a lien on the real property of the owner if the General is not paid in full by the owner. This is accomplished by the General’s filing of a Claim of Lien on Real Property (“Claim of Lien on Real Property”) in the county in which the real property is located. The General’s lien will be equal to the dollar amount of the labor or materials provided, or caused to be provided, by the General, minus any amounts paid to the General for such labor or materials.
The dangerous aspect of a Claim of Lien on Real Property for a buyer of new, or recently improved, property is that, while the Claim of Lien on Real Property can be filed for the first time long after the buyer has had the public records checked and bought the property at full price, the priority of the Claim of Lien on Real Property will “relate back” to the date any labor or materials were first furnished to the property and, thus, encumber the buyer’s title to the property. Therefore, it is a “hidden” lien that cannot be discovered by even the most diligent review of the public records relating to the relevant property.
How does the Claim of Lien on Real Property Work?
A General who has not waived the right to file a Claim of Lien on Real Property, as discussed below, and who has not been paid in full, can file a Claim of Lien on Real Property no later than 120 days after the last date the General furnished labor or materials the property. The General then must file a lawsuit to enforce the Claim of Lien on Real Property no later than 180 days after the General last furnished labor or materials to the property.
If the Claim of Lien on Real Property and the lawsuit are properly and timely filed and pursued, and the General prevails on the claims raised in the lawsuit, the General will be entitled to a court order that the sheriff sell the property and use the proceeds to pay the General the amount proven to be owed.
First-, Second-, and Third-Tier Subcontractors that have not been paid (but not fourth- and lower-tier Subcontractors) also have lien rights. These Subcontractors can attempt to secure payment by asserting a lien on the funds that are owed to the higher-tier contractor that hired them on the project. To exercise this right, the Subcontractor, within 120 days after the Subcontractor last furnished labor or materials to the project, must deliver a Notice of Claim of Lien Upon Funds (“Claim of Lien Upon Funds”) to the person or entity that owes funds to the higher-tier contractor that has failed to pay the Subcontractor.
In addition, First-, Second-, and Third-Tier Subcontractors also are entitled to claim liens by subrogation. Subrogation simply means “stepping into the shoes of another.” In other words, these unpaid Subcontractors are permitted to step into the shoes, and assert all of the lien rights, of those who dealt directly or more closely with the owner. This includes the ability, if available, to file a Claim of Lien on Real Property against the real property involved in the project. However, if there is no lien right, such as where an owner has made final payment to the General or there are no funds owed to a higher-tier Subcontractor, then there is no right to which the Subcontractor can be subrogated and, obviously, there can be no lien by subrogation.
For example, a developer owns a lot and contracts with a General to construct a building on the lot. In turn, the General hires a plumber to provide the plumbing for the building. The plumber finishes work, but the General fails to pay the plumber. The plumber then can serve upon the owner a Claim of Lien Upon Funds against any funds still owed by the owner of the property to the General and, if the General has not waived or released its lien rights, can file a Claim of Lien on Real Property. If the owner owes funds to the General, the plumber’s service of the Claim of Lien Upon Funds both: (1) warns the owner to withhold from the General funds equal to the amount claimed until the plumber certifies to the owner that payment has been made to the plumber, and (2) triggers the plumber’s right to file a Claim of Lien on Real Property by subrogation to the General’s Claim of Lien on Real Property. If the owner fails to require that the plumber be paid and, instead, fails to withhold funds and pays the General, the owner becomes personally liable to the plumber for the amount the owner paid to the General and, in addition, the plumber now can file its own Claim of Lien on Real Property against the owner’s property.
The Problem
In the past, the seller and the General often would provide the buyer with lien affidavits swearing that the General and all of the Subcontractors had been, or would be, paid in full. If a Subcontractor filed a Claim of Lien on Real Property, the buyer would require the owner and the General to honor their affidavits and pay the Subcontractor. However, in the current economic climate, many Generals and Subcontractors have gone out of business, petitioned for bankruptcy protection, or otherwise do not have money to pay their Subcontractors. As a result, the buyer, who thought the property had clear title when the buyer purchased it, faces a situation in which the buyer must confront the risks of either having to pay a second time for the improvements the Subcontractor made to the property or having the property sold by the sheriff to pay the Subcontractor.
For further information regarding the issues described above, please contact Thomas S. Babel.
