Owners of property encumbered by a mechanics lien often find themselves in violation of loan covenants and under pressure from their lenders. Liens are also a significant hindrance to the sale of the property to an otherwise willing buyer. How best to deal with a mechanics lien depends upon the circumstances, but here is a look at some options.
1. Bonding Over the Claim. In 2016, via amendment of the Illinois Mechanics Lien Act, Illinois joined most other states in providing a statutory process for bonding over a mechanics lien. Essentially, once a claim for a mechanics lien has been asserted, an owner or other eligible person having an interest in the subject property may petition the local court to substitute a surety bond in lieu of the property as security for payment of the lien. If the petition is timely filed, and no objection is presented and sustained by the court, an order will issue (1) substituting the surety bond for the property securing the lien claim, and (2) substituting the lien claimant’s right to recover on the bond for claims that could otherwise be asserted by the claimant under the Mechanics Lien Act. The order discharges the lien, and once recorded effectively releases the claimant’s encumbrance on the property. Litigation then proceeds among the claimant, surety and bond principal only. Other persons having an interest in the property who would otherwise be joined in the action are excused.
Some of the intended benefits of this process include (1) earlier release of the lien encumbering owner’s title; (2) simplifying litigation; and (3) providing a source of cash recovery to a successful claimant.
But there are downsides to consider. First: the size of the claim and bond. The bond must, in addition to other requirements, be in an amount equal to at least 175% of the sum claimed. Often, the bond principal is a general contractor constructing improvements to the property for the owner’s benefit, bound by the terms of its contract to permit no liens by subcontractors or suppliers. Unless a private project is very large, the owner may not have required the contractor to post a payment bond up front. Once the dispute arises, the financial burden on the contractor/principal to obtain a bond in the proper amount may be substantial. The same is true for an owner/principal whose budget for the project did not contemplate the need for a bond.
Second: the principal is jointly and severally liable with the surety for any judgment awarded to the successful claimant – including some or all of the claimant’s attorneys’ fees. A prevailing party clause in the statute provides that if the claimant is awarded at least 75% of the amount claimed, it is entitled to recover reasonable attorneys’ fees up to the penal sum of the bond remaining after payment of the award plus interest. The bond principal, on the other hand, becomes the prevailing party only if the claimant is awarded less than 25% of its claim, in which case the principal may recover attorneys’ fees up to 50% of the claim – if it is collectible. Unless the principal is very sure of its position, challenging the claim presents material risk beyond its own legal expenses.
2. Title Insurance. As an alternative to statutory bonding and litigation, an owner/seller can try negotiating for a title policy insurance over the lien (depending on size and other factors), but title companies are under no obligation to offer such coverage and will typically require the seller’s personal undertaking for all related losses in an amount up to two-and-one-half times the size of the claim. Even where this is a viable option for the seller, it may not be acceptable to the buyer, who will generally prefer to take a clean title.
3. Negotiate a Release. Liens arise because the claimant hasn’t been paid. More often than not, the claimant will prefer cash in hand, even at a discount, over taking its chances in court. The tried and true method of making a deal to exchange cash for the claimant’s release is typically more cost-effective, less disruptive and less risky than litigation – for both sides.
The relative contributions of the parties to the bargain will depend on the circumstances. Did the owner satisfy its obligation to pay the contractor? Even if true, payment to the contractor is not necessarily a complete defense to the claims of subcontractors. If the claimant is a subcontractor, the owner may have the incentive to chip in to a settlement and pursue other remedies against the contractor. Did the contractor make errors that increased the cost of a subcontractor claimant’s work? In that case, the contractor may be taking a haircut. Did the claimant fail to fully perform? If so, a reduction of the claim is in order.
When settlement is reached, the owner benefits by clearing title to the property; the would-be bond principal, whether owner or contractor, will avoid costs for the bond; all parties will save legal expenses; everybody avoids judgment; and generally speaking, an outcome the parties agree on themselves is better than one imposed upon them by a court. So, when weighing the options, consider taking the practical approach: just deal with it.