Nevada Supreme Court Holds That a Bad Check Invalidates an Unconditional Release of a Mechanics Lien

What happens if a lower-tiered contractor provides higher-tiered contractor with an unconditional release of mechanics lien rights in exchange for payment by check, only to have that check returned for insufficient funds? This was the scenario presented to the Nevada Supreme Court in Cashman Equipment Co. v. West Edna Assocs., 132 Nev. Adv. Op. 69.

The case involved the construction of the new Las Vegas City Hall. Whiting Turner Contracting (“WTC”) served as the Project general contractor. WTC selected Mojave Electric (“Mojave”) to serve as the Project electrical subcontractor. Cashman Equipment Company (“Cashman”) originally submitted a winning bid to Mojave to provide specialty materials. However, WTC mandated that Mojave involve disadvantaged business entities, so Cam was selected for this purpose to serve as an intermediary between Mojave and Cashman.

Pursuant to their respective agreements, Mojave paid Cam (the intermediary) for services provided by Cashman. In turn, Cam issued a check to Cashman for the equipment provided. Cashman executed an unconditional release of its mechanics lien rights in exchange for the check. However, Cam’s check to Cashman was returned for insufficient funds, and Cashman’s subsequent efforts to obtain payment were unsuccessful (Cam’s owner absconded with the payment from Mojave). As a result, Cashman recorded a mechanics lien and eventually filed suit to foreclose the lien.

The trial court refused to enforce Cashman’s mechanic’s lien and upheld the unconditional release despite the fact that Cashman had not received payment for its work. The trial court also found that Mojave’s payment to Cam constituted payment to Cashman because Mohave’s check to Cam was honored. Cashman appealed to the Nevada Supreme Court.

The Nevada Supreme Court reversed the trial court decision and held that the unconditional release was void. The Court compared the subject release to a “pay-if-paid” provisions commonly found in construction contracts. In a separate case, the Court previously had held that “pay-if-paid” provisions were unenforceable because they violate public policy. Lehrer McGovern Bovis, Inc. v. Bullock Insulation, Inc., 124 Nev. 1102, 1118, 197 P.3d 1032, 1042 (2008). Similarly, the Court found that enforcement of the subject release would violate Nevada’s public policy favoring mechanics liens to ensure payment to those who provide labor or furnish materials to improve property. The Court further found that the subject release was statutorily unenforceable pursuant to NRS 108.2457(5)(e), which precludes enforcement of a waiver when the payment exchanged for the release is in the form of a check that fails to clear the bank “…for any reason.”

Although not specifically discussed in this case, Cashman ultimately prevailed because it complied with the specific requirements set forth in Nevada’s mechanics lien statutes. This case is also illustrative of Nevada’s strong public policy protecting contractors’ payment rights.

Insight into the 90 Day Claim Rule

In the recent Picerne Construction Corp v. Castellino Villas matter, the Court interprets former Civ Code 3115 (regarding deadlines to record a claim of mechanic’s lien) and section 3131 (regarding the definition of a work of improvement).

Picerne agreed to build an apartment building complex comprised of 11 buildings for Castellino. Certificates of occupancy were issued on July 25, 2006, however Picerne continued to work after this date – there was roof work and installation of stairway grip tape that was still required under the contract. Though Castellino signed a document entitled “Owner’s Acceptance of the Site” on September 8, 2006, the roof and stairway work continued to sometime shortly after September 8, 2006. Castellino began renting the apartment units in October 2006. This was the same time that Picerne asked Castellino to release the project retention proceeds.

Picerne recorded a claim of mechanic’s lien on November 28, 2006 and filed a complaint against Castellino and others to foreclose its mechanic’s lien on December 29, 2006. The trial court ruled that the project was completed no earlier than September 8, 2006, that Picerne timely recorded its claim of mechanic’s lien, that Picerne was entitled to foreclose on its lien and that the lien was senior to the deed of trust in favor of Bank of the West. The trial court ordered Picerne’s lien foreclosed; Castellino appeals.

In the appeal, Castellino makes multiple arguments including: 1) Picerne did not have a valid mechanic’s lien because it did not record a claim within 90 days after substantial completion of the project pursuant to former Civ Code 3115 – that the date started to run as of July 25, 2006 when the certificate of occupancy was issued, and 2) each of the 11 buildings of the complex were separate residential units per the meaning of section 3131, thus different lien claim deadlines applied. The Court disagreed with both of these arguments. The Court reasoned that the Legislature deleted “trivial imperfections” in the predecessor to this Code and defined completion of the work of improvement as actual completion of the work. Ample evidence points to the fact that work continued between July 25, 2006 through September 2006, and that this work was not corrective work, repair work, nor warranty work, but that the work (which was roof work and grip tape application work) was required by the terms of the contract. Thus, the lien was timely recorded. The Court also discussed that under the meaning of section 3131, Castellino failed to show that there was separate title for each of the 11 buildings, and instead, that Castellino filed one notice of completion for the entire project, thus different lien claim deadlines are not applicable.

In short, actual completion is not to be confused with substantial completion and where the contract calls for specific work, that work must be completed before the time starts to run on the 90 day deadline to record a claim of mechanic’s lien. Also, where a work of improvement is comprised of multiple units/buildings, where there is no separate title for the individual units/buildings and where there is one notice of completion for the entire project, there are no separate deadlines, or deadlines calculated on a “per unit/building” basis.

The Nevada Supreme Court Develops Two Prong Test for Determining Lien Priority

In Nevada, as in many other states, mechanic’s lien filed by contractors, subcontractors and suppliers attach to the real property when “work is commenced.” This date is important because all mechanic’s liens filed against the property have priority over any mortgage, deed of trust, or other encumbrance which is recorded after that date.

Recently, the Nevada Supreme Court addressed when “work commences” or when mechanic’s lien attach in Byrd Underground LLC v. Anguar, LLC, 130 Nev. Adv. Rep. 62, 333 P.3d 273 (2014) and an unpublished decision Las Vegas Paving Corp. v. RBC Real Estate Fin. Inc., 2015 Nev. Unpub. LEXIS 1124 (Sept. 2015).

In these two opinions the Nevada Supreme Court established a two-step procedure for determining “when” the “work of improvement” commences. The Court stated that the scope of “the work of improvement” must first be determined from the facts admitted into evidence. The Court determined that the scope of the “work of improvement” must be established first because the “commencement of preparatory work” does not constitute “commencement of the work” and does not set the priority date for the mechanic’s liens. Once the scope of the “work of improvement” is defined then it can be determined when the “commencement of work” was first apparent by a reasonable inspection.

These recent Nevada decision may have added uncertainty to the establishment of priority but such uncertainty can only benefit contractor’s and subcontractors when questions arise as to when the work commenced and their liens attached.

New Illinois Law Will Allow Parties on Private Projects to Substitute Surety Bonds for Mechanics Lien Claims

As of January 1, 2016, the Illinois Mechanics Lien Act (“Act”) will contain an amendment that allows a property owner, contractor, subcontractor, or other party with interest in real property that is subject to a mechanics lien claim to substitute a surety bond in place for the mechanics lien claim. The procedure, referred to as “bonding off” a mechanics lien claim, will allow an interested party to file a petition with the county where the property is located to bond off a mechanics lien claim filed against the property. Alternatively, if there is already a pending claim to enforce the lien, within five months after the filing of the complaint, the interested party can apply to become a party itself and file a claim to bond off the lien claim.

This new amendment looks to benefit many parties involved in typical claims. For instance, a property owner will now be able to substitute a claimant’s lien on the property with a surety for the claimant in the event the claimant prevails on the claim. The amendment also helps affected parties supplying the construction activities to a project, as the surety bond will easily cover the amount in dispute (as the new law requires that the bond be valued at 175% of the amount claimed).

This new change will help ease the flow and progression of private projects that fall prey to mechanics lien claims, since there will be less likelihood of parties to have to wait out the resolution of the mechanics lien claim itself and final disposition of the subject property.

The Texas Construction Fund Act

Texas law on mechanic’s liens is not favorable to subcontractors, particularly those from out of state. Perfection of a mechanic’s lien requires subcontractors to provide repeated monthly notice to prime contractors and owners on an accelerated timetable, with notice deadlines often coming (and going) before payment issues become apparent. For example, first-tier contractors (that is, subcontractors who contracted with the prime), must send a letter by certified mail, return receipt requested, to the owner and the original contractor informing them of the unpaid claim not later than the 15th day of third calendar month following each month in which labor was performed or material delivered. Tex. Prop. Code § 53.056(b) (the so-called “Third Month Notice”). Failure to send a Third Month Notice (or multiple Notices, as the case may be), will result in lien non-perfection, even if the terms of the subcontract do not require payment at that point (if, for example, the subcontractor begins work on a six-month project in January and is not due to be paid until after the work is completed in June of the same year).

Further, to properly “trap” unpaid project funds in the hands of the owner (such that they are available to satisfy a mechanic’s lien), the Notice must contain specific statutory language set out in Section 53.056(d). Failure to send a timely Notice (or Notices), or to include the required statutory language, will result in no funds being “trapped” in the hands of the owner. And an owner’s liability on a mechanic’s lien is limited to funds properly “trapped.”

We frequently encounter situations where a subcontractor (particularly an out-of-state subcontractor) fails to comply with these strict requirements and is left without recourse against the owner. The only way to ensure valid perfection is to send multiple Third Month Notices, even if no payment obligations have arisen under the terms of the subcontract. For business-relation reasons, many subcontractors are reluctant to take this step.

Fortunately, the Texas legislature has balanced the scales somewhat with the Texas Construction Fund Act (the “Act”). The Act applies to those furnishing labor or materials for the construction or repair of a house, building, or improvement on real property, and provides that any funds paid to a contractor, subcontractor, or supplier made in payment of labor or materials are held in trust for all parties in the construction chain. Tex. Prop. Code §§ 162.002 and 162.003. The Act acknowledges a basic reality of modern construction projects: that prime contracts generally deposit project monies into a few common accounts, and it allows subcontractors and suppliers to recover from these funds without first pleading entitlement to these funds. See Holladay v. CW&A, Inc., 60 S.W.3d 243, 246 (Tex. App.—Corpus Christi 2001, pet. denied).

The Act accomplishes this goal in four ways. First, it treats “construction payments”—defined as payments made to a contractor or subcontractor, or an officer, director, or agent of a contractor or subcontractor, under a construction contract for the improvement of specific real property in Texas—as trust funds. Tex. Prop. Code § 162.001.

Second, the Act treats certain recipients of construction payments as trustees. The universe of potential trustees is broad, and includes contractors, subcontractors, or owners, or officers, directors, or agents of a contractor, subcontractor, or owner who receives trust funds or who has control or direction of trust funds. Tex. Prop. Code § 162.002.

Third, it provides an expansive definition of beneficiaries, which includes any artisans, laborers, mechanics, contractors, subcontractors, or materialmen who labors or who furnishes labor or material for the construction or repair or an improvement on specific real property in Texas. Tex. Prop. Code § 162.003(a).

Fourth—and most importantly—the Act allows for civil and criminal liability for any trustee who intentionally, knowingly, or with intent to defraud “directly or indirectly retains, uses, disburses, or otherwise diverts trust funds without first fully paying all current or past due obligations incurred by the trustee to the beneficiaries of the trust funds. Tex. Prop. Code § 162.031(a).

It is not difficult to imagine circumstances constituting misapplication. For example, a prime contractor who uses progress payments from an owner for Job A to pay subcontractors and vendors on Jobs B and C has misapplied those progress payments, even if the payments on Jobs B and C were not made with an express intent to defraud. Under such circumstances, an unpaid subcontractor on Job A can bring a civil claim not just against the contractor, but also its owners, officers, directors, and agents of the contractor (as well as anyone else at the contractor who had control or direction of the payment of the construction fund), and expose these individuals to personal liability.

Obviously, a claim under the Trust Fund Act is not a silver bullet. Recovery depends on the ability to prove misapplication, there are certain affirmative defenses available to the defendants, and the some or all of the defendants may be judgment proof. In this sense, it is not equivalent to a properly perfected mechanic’s lien, which allows the subcontractor to recover “trapped” project funds though a simple foreclosure process.

That said, a Fund Act claim is a powerful tool, as it exposes individual defendants to personal liability, and the threat of such a claim can be a very powerful motivation to encourage contractors to resolve unpaid subcontract amounts.