NC construction industry stakeholders divided on lien/bond law proposed changes

Possible changes to North Carolina’s lien/bond laws are attracting widespread attention throughout the state’s construction industry. Many of the affected parties — contractors, subcontractors and suppliers, title insurers and even construction lawyers — have problems with the existing rules, especially in the wake of three rulings that have been handed down by the Bankruptcy Court of the Eastern District of North Carolina. The problem is, the issues are different depending on the affected sector

Trying to mediate the various solutions is the North Carolinas Bar Association’s Construction Law Section Lien/Bond Law Revision Committee. The Section, chaired by Nan Hannah of the Raleigh office of Vann & Sheridan Attorneys at Law, drafted proposed legislation to change law after seeking input from all the stakeholders. On February 18, the Construction Law Section Council, the governing body of the Section, voted 11-4 to accept the latest draft version which must still be approved by the NC Bar Board of Governors. “We will be working with Kim Crouch, the Director of Governmental Affairs for the NCBA, to seek the final approvals needed from the NCBA in order for this proposal to proceed to the legislature under the auspices of that organization,” says Hannah.

“The lien law in North Carolina is virtually unchanged since 1969,” Hannah notes. “A lot of Band-Aids have been applied to it since then — small changes that were reactive to changes in the industry. That’s meant we ended up with a law that’s less effective than when it started.” Historically, she says, the law has been revised every 20 years. “So we’re about 20 years late now.”

Each of the stakeholders cites different views. For the title-insurance industry, the problem is so-called “hidden” liens. Hidden liens occur most typically when a building is finished near the closing date — say 30 days before. The title insurer does its search for the closing, finds no liens encumbering the property and issues title insurance. The transaction closes. Meanwhile, the contractor who dealt directly with the owner hasn’t been paid.  As the law stands, he has 120 days from the time the work was completed to file the lien. When the lien is filed, the building owner files a claim against the title insurer, which is then obligated to make the title good.

General contractors, meanwhile, say they have been bedeviled by the issue of “double payments” to subcontractors and suppliers. Keith Coltrain, an attorney with the Raleigh office of Elmore & Wall, P.A., says the problem arises when a general contractor on a bonded public project hires a first-tier subcontractor who then later fails to pay its own subcontractors and suppliers. This is a particular problem when the first-tier subcontractor then files bankruptcy or otherwise becomes insolvent. The general contractor is still liable to the second and third-tier claimants even if the general contractor has paid the first-tier everything it is owed. In those situations, the general contractor has to pay twice for the same work. A simple solution to this problem, Coltrain says, is to require potential bond claimants to give the general contractor written notice that they are working on the general contractor’s project. With that notice, the general contractor has information by which it can protect itself, i.e., by making sure the lower-tier subcontractors are timely paid each time the general contractor makes a payment to the first-tier subcontractor.

Subcontractors and suppliers, meanwhile, say the bankruptcy court rulings have effectively stripped them of lien rights unless they established them prior to the bankruptcy filing by a contractor or upstream subcontractor. Ned McNaughton, a Charlotte lawyer at McNaughton & Associates and a member of the American Subcontractors Association of the Carolinas, says the revisions in the lien/bond law will reverse the rulings. “Up until these cases, it has been understood that a subcontractor could still file a lien after the owner or upstream contractor filed for bankruptcy.”

Hannah thinks it is important to clarify that those subcontractors and suppliers who elect to utilize the Notice to Owner at the outset of their involvement on a project will have lien rights which relate back to the Notice of Commencement. “If they choose for whatever reason to wait, they can still serve a Notice to Owner at any point, but after the initial 30-day window, a later filed Notice to Owner will related back to all amounts due for the 30-days prior to the date the Notice to Owner is served and filed,” she explains. “If someone elects to completely ignore the Notice to Owner process, they still will have access to the Notice of Claim of Lien Upon Funds as it operates today,” she adds.

The other stakeholders are the attorneys representing those clients. As the law is presently written, it’s difficult to recover legal fees in their cases. That, says Gene Rash, a partner in the Charlotte Office of Smith, Currie & Hancock, means that litigants are reluctant to pursue cases because their legal costs can outstrip what they recover. Under the present law, a judge must make a finding of an unreasonable refusal to fully resolve the case by one side or another.

Dave Simpson, N.C. building director for Carolinas Associated General Contractors, says that while building contractors have major problems with the issue of double payment, others believe that the notice provisions may be too burdensome. “I have heard from many building contractors across North Carolina who have unfairly had to pay twice for the same work or materials—and we’re talking about big bucks,.” Simpson says. “It’s a bad, risky way to do business and I think everybody agrees nobody should have to pay twice. This double payment issue is not going away until there is some relief.”

The proposal being offered by the Bar Association committee — the complete text of which is available here — addresses the problems as follows:

Hidden liens: The owner or general contractor of a project would be required to post a notice of commencement identifying the owner, lender and general contractor before work begins. Lien rights will revert back to the filing of the notice of commencement.

Double payment: All subcontractors, suppliers and other participants on a bonded public project would be required to serve a notice to the general contractor. Their claims on the general contractor’s payment bond would be limited to the labor and materials provided within 30 days prior to serving the notice.

Subcontractor and supplier lien rights: Participants in a project that file a Claim of Lien on Real Property take priority from the time of the filing of the Notice of Commitment. The revisions also preserve their rights to file a Claim of Lien on Funds, essentially reverting conditions to the way they were prior to the recent bankruptcy court rulings.

The latest draft of the lien law revisions doesn’t address attorney’s fees. However the issue may be revisited at some future date. Stakeholders point to the South Carolina’s lien law, which allows each party to make a settlement offer. The dividing line for determining the prevailing party is the midpoint between the positions. The award of “reasonable” attorneys fees to the prevailing party, not to exceed the amount of the lien, is mandatory. “The South Carolina law looks after the interest of all the litigants that have legitimate claims,” Rash says. “The law also encourages reasonable offers of settlement.”

Even the most-ardent supporters of change concede that it has a tough road ahead. First and foremost, the NC Bar Association’s Board of Governors must approve the proposed changes and then find a sponsor in the General Assembly.

The talks so far have been quite civil and professional according to Hannah. “There are disagreements as to whether the proposed process is the best course, but I am quite proud of the breadth of the construction industry which has been able to disagree without rancor,” Hannah adds.

“It’s hard to get all the stakeholders to rally around something to pass. The charge my committee has had from the get-go is figuring who benefits and who doesn’t, and how do you balance that?”