PA Mechanic's Lien Waivers, Releases: The Nuts and Bolts
Much of the landscape concerning mechanic's liens in the commonwealth of Pennsylvania has changed since January 2007 due to a series of amendments to the Pennsylvania Mechanics’ Lien Act. While it has been eight years since the first dramatic changes were made in 2007, subsequent amendments addressed problems or other issues that the 2007 amendments created. The purposes of this article is to assist practitioners and others documenting commercial real estate transactions regarding mechanic’s lien “waivers” and mechanic’s lien “releases” in transactional documents in Pennsylvania.
Pennsylvania Mechanic's Lien “Waivers”
Prior to the enactment of the 2007 Mechanics’ Lien Act amendments, it was standard procedure in Pennsylvania to have pre-construction mechanic's lien waivers filed with the prothonotary in the county in which the subject property was located. The act, as then in existence, permitted a contractor and owner to execute a pre-construction lien waiver which, if properly executed, prepared and timely filed, negated the ability of the contractor and that contractor’s subcontractors from liening the subject property. Pennsylvania was very unique in allowing these pre-construction lien waivers. Many other states, by statute or otherwise, did not (and still do not) permit pre-construction lien waivers as being against public policy.
Prior to the 2007 amendments, the tiers of entities with lien rights were limited to “contractors” and “subcontractors.” A “contractor” is one who directly contracted with the “owner” and provided lienable services or materials. A “subcontractor” is one who contracted directly with a “contractor” and provided lienable services or materials. Depending on the project, there could be multiple “contractors” if multiple direct contracts were executed between the owner and one or more “contractors.”
Prior to the 2007 amendments, sub-subcontractors had no lien rights. The 2007 amendments increased those entities with lien rights by creating a new tier that could lien a project. The new tier was sub-subcontractors. The amended act does not have a definition of “sub-subcontractor” but instead includes sub-subcontractors in the definition of “subcontractors.” This new tier includes any person or entity that furnishes labor or skills, or supplies or hauls materials, fixtures, machinery or equipment for the project through an express or implied contract with a subcontractor in privity with a contractor.
Another material 2007 amendment made pre-construction lien waivers no longer valid as being against public policy with certain limited enumerate exceptions. Subsequent amendments built on these several exceptions under which pre-construction mechanic's lien waivers are permitted. These currently are:
Residential Property. Pre-construction lien waivers are still effective for “residential property.” “Residential property” is property (1) on which there is or will be constructed a residential building of not more than three (3) stories in height (excluding the basement level), or (2) which is zoned or otherwise approved for residential development and upon which will be constructed a residential building of not more than three (3) stories in height (excluding the basement), or (3) which has a residential subdivision plan, land development plan or planned residential development plan that has received preliminary, tentative or final approval on which there will be constructed a residential building not more than three (3) stories in height (excluding the basement).
The definition of what constitutes “residential property” is less than clear. It would exclude a three-story building with ground-floor retail and two stories of apartment or residential condominium units. A purely multifamily housing structure would be included so long as the height limitation is not breached. The definition does not restrict “residential property” to those that are, or are intended to be, owner-occupied.
Nonresidential. Pre-construction lien waivers for projects that do not qualify as “residential property” are effective only against subcontractors provided the contractor has “posted a bond guaranteeing payment for labor and materials provided by subcontractors.” This limited pre-construction lien waiver would still be filed by the contractor with the county prothonotary and, while not expressly required in the act, should recite that there is a payment bond obtained by the contractor to help support the effectiveness of the lien waiver.
Nothing in the act addresses the form or exact nature of the required bond other than it must be a “bond guaranteeing payment for labor and materials provided by subcontractors.” At this point, practitioners using this approach to limit lien rights have been using standard payment bonds with the obligee identified as the owner and any lender as “dual-obligees.” It is really not possible, or advisable, to name the subcontractors as obligees under the bond for a couple of reasons.
First, at the time of issuance, not all subcontractors and sub-subcontractors will be known. In fact, as noted above, the universe of all subcontractors and sub-subcontractors may be very difficult to know. Second, the bonding companies want to know who the obligees are and this makes that impossible. Third, issuing as a named beneficiary something like “all subcontractors provided labor or materials for the contractor of xxx” is not feasible or practical, especially if recourse to the bond is necessary.
For these reasons, and unless later case law or a further amendment to the act dictates otherwise, obtaining a payment bond or a payment and performance bond may suffice. It should be noted, however, there is currently no case law on the point to provide actual guidance. For nonresidential real estate, an additional issue is the cost to obtain the necessary bond. This cost, depending on the project and the contractor, may not be acceptable.
Mechanic's Lien Releases
The amended act continues to recognize mechanic's lien “releases.” Under the act, lien releases are enforceable to the extent given in exchange for payment received. There are generally two types of mechanic's lien “releases.” The first are interim mechanic's lien releases that are executed, often monthly, by those with lien rights to relinquish those lien rights in exchange for their periodic payments under their contracts or subcontracts. The second type are the final lien releases executed at the end of the project by those with lien rights in order to release and relinquish all of their rights to file a lien against the subject property and confirm that all sums due then have been paid in full.
Prior to the 2007 amendments, it was relatively easy to address in transactional documents from whom lien releases should be obtained, whether on an interim basis or final lien releases at the completion of a project. The owner would know each contractor with whom it contracted directly. In turn, each contractor would know the subcontractors with whom it contracted or who otherwise provided labor material or materials for the project. Therefore, obtaining interim and/or final lien releases from this universe of potential lien claimants, while not always easy, was achievable.
The 2007 amendments changed that dramatically by creating the new tier of entities who have lien rights — the sub-subcontractors. The problem becomes obvious that while the owner knows who its contractors are, and each contractor knows who its subcontractors are, very often neither the owner nor the contractors knows the universe of what entities constitute the sub-subcontractors. Sub-subcontractors include any person or entity that, pursuant to an express or implied contract with a subcontractor in direct privity with a contractor, either provides labor or materials for the project.
So, in theory, a subcontractor could go to the local big-box supply store, buy $10,000 worth of materials, incorporate those materials into the project and not pay the big-box supply store. In this circumstance, the big-box supply store would be a sub-subcontractor and would have lien rights. When the time comes for delivery lien releases, neither the owner nor the contractor may know that the big-box supply store is a sub-subcontractor and even if they did, it would be virtually impossible to get a mechanic's lien released from it. While this example may seem somewhat extreme, it is a good example of the problems created by creating the additional tier of sub-subcontractors with lien rights.
Transactional Structuring and Drafting to Address These Issues
First, for purposes of clarity and conformance of the transactional documents with the definitions in the act, the practitioner should use best efforts to use the same terminology as used in the act and properly identify when a mechanic's lien “waiver” is required a precondition of closing and when mechanic’s lien “releases” are required on either interim or end-of-the-project basis. Using the right terminology can avoid issues later in interpreting the terms of the transactional documents.
Second, the practitioner needs to discuss with the client the benefits and burdens of obtaining a payment bond for any nonresidential project where the act permits the use of pre-construction lien waivers to negate the lien rights of subcontractors and sub-subcontractors. There is obviously a cost in obtaining the payment bond, assuming the applicable contractor is “bondable,” that may weigh against obtaining the bond. It is important to note that even when properly documented, and the proper payment bond is obtained, the pre-construction waiver mechanic’s liens will only be effective against the subcontractors (and sub-subcontractors) and will not be effective against the contractor itself.
Third, the practitioner needs to discuss with the client the universe of possible lien claimants from whom interim and final construction lien releases should be obtained. Because of the difficulty in identifying the sub-subcontractors and the fact that there may be some very small sub-subcontractors on a particular project, very often the parties may negotiate a minimum subcontract amount to limit the universe of those from when lien releases should be obtained.
For example, the parties may agree that only lien releases should be obtained from the contractors and those entities that constitute “major subcontractors.” For example, a “major subcontractor” could be any subcontractor or any sub-subcontractor with a contract of, for example, $50,000 or more. In order to support this, the transactional documents with the contractor should require that the contractor will provide to the owner a complete and updated list of all subcontracts when and as executed. Further, the contractor should require its subcontractors to identify its sub-subcontractors. This information can then be used as the project proceeds to assist in obtaining the necessary interim and final lien waivers.
For additional information, contact Tom Rogers at 215.864.7190 or firstname.lastname@example.org.