General contractors, lenders, title insurance companies, owners, and sureties on a construction project are concerned about their exposure to mechanics lien claims. This is natural since these claims are a large component of the project’s financial risk. Despite these parties’ ambition to avoid liens, it is illegal in 47 of the 50 states to ask subcontractors and suppliers to give away their mechanics lien rights within the construction contract, or before that party begins furnishing labor or materials to the project.
It digs into the meaning of law in America and our nation’s public policy priorities.
Chris and I’s debate is highly interesting (really, it is) because, generally, it digs into the meaning of law in America and our nation’s public policy priorities, and specifically to the construction industry, the debate is crucial to how financial risk and legal risk is and should be allocated on a construction project.
When Its Time To Make Payment on a Construction Project…What Is Fair?
Chris’ question is a very good question: Do we really want courts deciding if our construction contracts are fair?
Fairness is an abstract concept, and there’s a lot of built-in elasticity depending on a parties’ perspective. Richard Korman of ENR captures this perspective problem in his summary of a seminar from the 2013 ENR Risk Summit. In “Views differ from places on the payment flow chart,” Korman describes subcontractors in a fight to “kick and scream” for payment reform, and general contractors in a fight to “stay ahead” of the subcontractors in the payment schedule.
Fairness, in other words, can significantly vary depending on a party’s perspective.
One of my law professors, Judge Joseph C. Wilkinson, used to say something in class when describing certain case outcomes that really stuck with me: “Fairness,” he’d say, “is something they teach you in kindergarden.”
Accordingly, I wholeheartedly agree with Chris Hill that we should not leave it to judges to determine whether a construction contract is or is not fair.
However, I strongly disagree with Chris’ suggestion that fairness is something that the parties can fairly (pardon the term) negotiate. In his Construction Law Musings post, Chris discusses this point as follows:
Is one person’s idea of “fair” better than another’s when both parties to the contract had the full ability to read, negotiate and possibly reject the deal long ago? Personally, I think that the answer to these questions is, in all but the most egregious cases or where the legislatures have stepped in adding certainty (whether to the good or bad), “No.”
The next section of this post will break down this comment into two discussions. First, the post will discuss the “most egregious cases” where the legislatures have stepped in to add certainty to the fairness debate. And second, the post will discuss the ability to “read, negotiate, and possibly reject” unfair contractual clauses.
The Freedom of Contract, The Rule of Law, The Police Powers, and How The Mechanic Lien Fits In
One of America’s most important legal principles is the “freedom of contract,” and this freedom of contract is the crux of the argument in favor of allowing subcontractors, suppliers, and any other parties waive their lien rights at any time. If a party wants to waive their right to lien, they should have the contractual freedom to do it.
The “freedom of contract” principle has it’s own Wikipedia page. It’s a big deal.
One of the most famous examples of the “freedom of contract” debate happened during Franklin D. Roosevelt’s struggle to pass New Deal legislation, and specifically the Fair Labor Standards Act of 1938. According to the Department of Labor, that act “establishes minimum wage, overtime pay, record keeping, and youth employment standards” in the private and public sector. The FLSA, in other words, substantially limits a party’s freedom to contract.
The FLSA was subject to significant debate in its day, and that debate centered around the freedom of contract principle. In fact, the debate continues today, as our country is consumed in a debate over whether the “minimum wage” should be transformed into a “livable wage.”
Don’t minimum wage employees have the right to just go work somewhere else? Can the country — and maybe more importantly, should the country — really force a private employer to pay people a certain amount? And where does a government draw the line? Is “minimum” enough, or must it be “livable?” And then to that point, what is “livable” anyway, and how will that be determined on an on-going basis.
There is no doubt that the freedom of contract principle in America is subject to policy considerations. Chris understands this, as he admits that such legislative interference is applicable in the most “egregious” circumstances. The suggestion, therefore, is that the contractual relationship between owners, general contractors, subcontractors, sub-subcontractors, laborers, and suppliers do not present such egregious circumstances.
However, I would disagree. Furthermore, the vast majority of legislatures in the United States disagrees, and that disagreement has a profound and long-standing history dating all the way back to Thomas Jefferson and James Madison.
It was two of our founding fathers who brought the mechanics lien instrument in America. The concept was simple, and it’s a concept that permeates throughout American law and public policy. The concept is this: Those who do work and furnish materials, for the benefit of another, should not be saddled with the risk of non-payment.
When someone is employed by a company, it’s pretty clear that they must be paid a salary. It doesn’t matter if the company’s best client doesn’t pay an invoice on time, or terminates their contract. The company must maintain the proper working capital to pay its employees, and the company ultimately bears the financial risk of something going wrong.
The developer and the lender, and to a lesser extent the general contractor, are the ones in control of their money and how it distributed.
The financial risks on a construction project – i.e. the risk of not being capable of making payment down the contracting chain – is a risk that is controlled by top-of-chain parties. The developer and the lender, and to a lesser extent the general contractor, are the ones in control of their money and how it distributed. The sureties and the title insurance companies are paid to insure against those risks. It is contrary to American policy to allow these parties to shift that risk down the chain to people who have no control over it.
In fact, the mechanics lien instrument is designed to specifically offset this possibility. There are plenty of other types of laws in place to have the same effect in the context of regulating construction relationships. Two examples are prompt payment statutes and regulations, and civil and criminal laws against the misappropriation of funds on a construction project.
Despite this, owners, general contractors, lenders, and other top-of-the-chain parties have tried to circumvent this clear American public policy through onerous contract terms. We wrote about this history in this post: Getting Paid in the Construction Industry: A War Between Policy, Contract, and Tempers.
No lien clauses, the topic of the recent Virginia legislation, is just one tool that these top of the chain parties use to circumvent the policy favorable to lower-tiered parties. They also use pay-when-paid and pay-if-paid provisions, onerous post-work lien waivers, contract notice timing provisions, and more.
The problem comes back to fairness and the question of what is fair. Chris Hill’s post wonders whether we should let courts decide what is and what is not fair, but that puts us on only a short journey to the question of whether the parties should decide what is and what is not fair. In general, as Chris states, the answer to that second question is yes. People and companies have the freedom of contract in America, after all.
Sometimes, though, there are egregious cases, and the debate between Chris and I really boils down to that. Is payment in the construction industry one of these egregious circumstances that requires public policy to step in and play interference?
A lot of existing laws and 48 of the 50 states believe that it does. So do I, and the next section explores why I believe this in more detail.
Contractors and Suppliers Do Not Have Enough Leverage To Negotiate Construction Contracts Alone
It is not a lobbying accident that mechanics lien laws exist to protect suppliers, laborers, and contractors. Nor is it an accident that an assortment of other statutory protections clutter the freedom to sign onerous construction contracts. For hundreds of years, federal and state legislatures in America have stepped into contract negotiations between construction participants for two primary reasons: (i) Because the top of the chain has loped-sided leverage; and (ii) Because the top of the chain frequently tries to shift financial and legal risks that they control down to parties at the bottom of the chain who do not control the risks.
In the mechanics lien context, the public policy purposes behind these laws are not a secret. Actually, the public policy reasons are explicit, and they are explicit as to these above two points.
Consider, for example, states like Texas, North Carolina, and California, where the mechanics lien right is built into the state’s constitution. Or recent cases that debate the application of strict or liberal construction of lien laws, such as the Williams v. Athletic’s Field case in Washington state, where that state’s Supreme Court corrected lots of misunderstanding about the policy behind lien laws by explaining:
The strict construction rule, at its origin, was invoked to determine whether persons or services came within the statute’s protection. Expanding the rule of strict construction beyond this inquiry effectively nullifies [the purpose of the lien laws]…to the extent…[any]cases suggest that the statute’s mandate of liberal construction has been supplanted by a common law rule of strict construction, we disapprove them.
It is also worth noting that the legislative and judicial trend has been towards expanding the policy protecting tradespeople, subcontractors, suppliers, and other bottom of the chain participants…and not restricting it. One example of this trend is interesting in the context of Virginia’s recent changes, and that example is around lien waiver regulations.
In the past three years, California, Texas, and Mississippi drastically amended their mechanics lien laws to include specific restrictions around the lien waiver document. One reason for this change is that the marketplace — that is, the top of the chain — is increasingly demanding that bottom of the chain participants sign onerous and unfair lien waivers to get paid. If you thought that the construction contract and the awarding of work was powerful leverage to negotiation terms, just imagine the leverage a party has to get a simple lien waiver signed in exchange for immediate, cold, hard cash. It’s enormous. And problems with this play out in courts constantly.
Zachry Construction spent years, and lost millions of dollars, litigating about some unfair text within a lien waiver in Texas. There was recently a $350m lien waiver dispute in West Virginia, and Nevada recently had to review strange lien waiver practices and unfair waiver demands in a case that dug into the common practice of demanding “unconditional waivers” before payment is made, and a case in Utah pointing out the problem and practical limitations of reviewing lien waivers, which frequently get approved without much review.
These days, many general contractors and property developers are adopting tools like Textura’s Construction Payment Management platform. This tool empowers general contractors and developers to electronically request that subcontractors and suppliers transmit lien waivers up the chain before any payment gets released. There is no “negotiation” of the lien waiver terms, and no wiggle room at all.
Just a few months ago, this exact situation came before a New York Supreme Court (Kings County), whereby a “robo-lien waiver” was put before a contractor through the Textura platform, and signed. Later, the signing party argued that the waiver was unfair and was so transactional that it did not rise to the level of a legal agreement. The New York court agreed, invalidating the Textura lien waiver. In The Laquila Group, Inc. v. Hunt Construction Group, Inc. had this to say about the waiver exchange:
Plaintiff argues that, as the releases appeared on forms required for payment, the forms acted only as receipts and did not convey a true intent by the parties to waive all claims…The Appellate Division has, in factually similar cases, found questions of fact concerning the intent of parties executing purported release and the applicable scope of such agreements…
Chris Hill’s article on Construction Law Musings asks whether we should let courts decide what is fair about construction contracts. I believe we are in total agreement to this point: courts should not decide what is fair. A survey of court cases demonstrates, however, that they are constantly reviewing strong-arm provisions, onerous leverage tactics, and more, and having to make ad-hoc determinations of what is fair and what is not fair.
The United States has long set it’s policy on the point of these tactics, and the policy is in favor of the bottom tier parties. The parties without control of the purse, and thereby, control of the financial risk.
Lawyers see the lien waiver document and lien waiver clauses within contracts as something that can be “read, negotiated, and possibly rejected.” In reality, however, this is a practical up-hill battle. It may work for big general contractors, big specialty subcontractors, or heavy-highway folks who have a low volume of projects and can pour over the details of every transaction. Many building product manufacturers, suppliers, and trade contractors and laborers, however, blow through hundreds or thousands of projects a month. It’s just not practically possible.
And even if it was practically possible, these other parties do not have the leverage to make any changes. They need the work, or they need the cash, and signing a loaded contract or a loaded lien waiver is just the price of admission. That’s egregious, and it’s been recognized as egregious for a long time in the United States. Now, it is a bit more so in Virginia.
Chris, thanks for kicking off this debate. I love this topic. Would love to have folks chime in with their thoughts, and that includes, Chris.