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Preliminary Notices and Conditional Lien Waivers: Insulation Against Financial Risk

Financial risk on construction projects is a hot potato. Nobody wants to get burned by it, and everybody is always trying to toss it to somebody else.

Why? Because construction projects are inherently complicated and difficult to complete without hiccups. Weather intervenes, or a single workmanship dispute erupts, and a domino effect sends delays and payment dilemmas rippling through the entire job.

Consequently, businesses ranging from developers and general contractors to subcontractors and suppliers have increasingly taken contractual and practical measures to protect themselves. While some of these practices are reasonable and legitimate, they sometimes run into opportunistic territory. These can hurt parties at both the top of the chain (e.g., property owners and general contractors) and the bottom of the chain (e.g. suppliers and subcontractors).

Following are two simple steps both groups can implement to insulate their financial risk and promote fair payment processes for all parties.

Use Preliminary Notices

The preliminary notice, sometimes called a pre-lien or notice to owner (NTO), is a best friend to any party providing labor or materials to a construction project.

For lenders, property owners and general contractors

Preliminary notices were introduced to the benefit of these top-of-chain parties, specifically to prevent a property from receiving a “surprise” mechanics lien.

On medium and large jobs, it’s common for the property owner (and even the general contractor) to be unaware of subcontractors, sub-subcontractors and materials suppliers providing labor or supplies. It’s also not uncommon for one of these businesses to file a mechanics lien because of a payment dispute far removed from the property owner. Remember, though, that liens are filed against the property, not against a specific person or business. Thus, an unsuspecting property owner (or general contractor), unaware of problems occurring between subcontractors and sub-subcontractors, might one day wake up to find that the property has been liened.

Preliminary notices are designed to inform top-of-chain parties of who is involved on a job, at the start of work, before payment even has the opportunity to become a problem. General contractors and owners should request this information as a way to boost their visibility of the project. This enables them to intervene when problems (financial or otherwise) arise in order to prevent a lien from being filed. Many states also allow owners, or owners’ agents, to file a notice of commencement, which requires bottom-tier parties to give preliminary notice.

For equipment lessors, suppliers and subcontractors

Thirty-four states require bottom-tier parties to send preliminary notice in order to protect their right to file a mechanics lien. In these states, it’s imperative to send preliminary notice, as losing the ability to file a lien immediately leads to greater financial risk. Not to be abused itself, the mechanics lien is the greatest tool one has in construction for overcoming payment abuses. Losing the option to file a lien by forgetting to send preliminary notices is unforgivable.

Sending preliminary notice also fosters better working relationships, which in turn leads to smoother project completion and payment. A recent zlien survey found that 30 percent of respondents found receiving preliminary notices to be helpful, and 55.8 percent said they had neutral feelings.

Use Conditional Lien Waivers

Everybody in construction has dealt with lien waivers at one point or another. Lien waivers present risks to everybody in construction. Bottom-tier parties might accidentally give away their lien rights without ever receiving payment. On the other hand, top-tier parties who neglect to collect waivers (or who sign faulty waivers), might find themselves making double payments. For example, a subcontractor could file a lien and force payment from a property owner, even though the owner already paid the general contractor, and the payment issue was between the general contractor and the subcontractor.

From an objective point of view, lien waivers, when executed properly, are fair. A subcontractor receives $5,000 for work performed and that subcontractor gives up the ability to file a lien for that same $5,000. The problem is, like two kids trading toys, lien waivers present a catch-22: Who should go first? Does the payee give up lien rights before receiving payment, or does the payer make payment first?

In the 12 states that require a statutory lien waiver form, this isn’t a problem. (It is always advisable, even in these states, to carefully read and understand a lien waiver before signing.) Everywhere else, the solution is simple: Use conditional lien waivers. Like their name suggests, conditional lien waivers only kick into effect when the conditions stipulated in the waiver are true. Almost always, this condition is that payment has been made.

Unconditional waivers, which take effect once they are signed, present significant financial risks. Chiefly, it’s easy for the payee to sign away lien rights and never get paid, either because disputes arise, checks bounce, etc.

Conditional waivers, as long as they are drafted a reviewed with attention, protect the paying party from double-payment and the receiving party from non-payment.

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