Tools to Deal With Project Lenders and Prime Contractor Risks
For most contractors, one of the biggest risk-management issues is getting paid. In today’s economic times, many lenders have been forced to foreclose on a loan made to a project owner or developer. When this happens, contractors can be left holding the bag if the lender’s claims wipe out the contractor’s lien rights. Minimize the chance of losing out by recognizing when a lender, through the owner/developer, asks the prime contractor to consent or subordinate the contractor’s rights to the lender by signing documents.
When a private owner borrows money for a project, there is likely a deed of trust furnished to secure the loan on the project’s property. A deed of trust is a written pledge of real property given by the mortgagor to secure a debt and operates in much the same way as a mechanic’s lien. Lenders try to protect their investments by, among other things, requiring the prime contractor’s consent to secure priority over mechanic’s lien claims from the contractor and its subcontractors and by asking for approval rights in connection with changes to the prime contract. Contractors should know that they can—and should—try to negotiate the best possible terms when faced with such requests.
Lenders usually require that the deed of trust be recorded in the real property records before commencing work because lenders insist on priority over subsequent recorded liens. If a prime contractor has properly perfected a mechanic’s lien claim, the effective date for priority purposes is deemed the date construction commences or materials are first delivered to the site. The contractor’s lien claim “relates back’’ to this date.
Because priority usually involves a concept known as “first in time,’’ if the project lender decides to foreclose on a deed of trust that was recorded before work began, the lender will generally have priority over the contractor’s mechanic’s lien claim. There is an exception to this in Texas. Texas courts have recognized that a contractor’s mechanic’s lien claim against “removables” will survive a deed of trust foreclosure action. A removable is an improvement that can be removed from a structure without material injury to the land, preexisting structures or improvements to be removed from the structure.
A contractor may sue to foreclose on its mechanic’s lien claim against the removables even if the deed of trust has priority. The court decides what is a removable based on the facts of the case. In the past, courts have concluded that air-conditioning and heating units and carpet, among other items, constituted removables the contractor could foreclose on.
Although lenders often require the deed of trust be filed before work begins, they often ask the borrower, or project owner, to obtain consent from the prime contractor to subordinate its interests in the project to those of the lender. Such documents may be titled “Contractor’s Assignment” or “Subordination Agreement” among others. Lenders ask for these documents to obtain authority to step into the owner’s shoes if the owner/borrower defaults on the loan and to obtain a full waiver of the contractor’s mechanic’s lien rights. Lenders may also use such documents to require that the contractor waive its right to lien against removables.
Contractors should be careful when asked to sign a consent that requires the prime to include similar consent and subordination language in all subcontracts and material purchase contracts. Often, the subcontracts have already been executed and prime contractors should not accept the responsibility without passing it on to the subcontractors if you can’t negotiate this requirement away.
Another use of these documents involves a lender’s attempt to gain priority for the deed of trust if it was not filed before work began. This could happen if a project owner borrows money to complete a project after work starts. Contractors should know that there is no legal obligation to sign such consent documents. If the owner needs the loan to begin the project, a contractor may have to decide how badly it wants the job before agreeing to sign. If the owner seeks the consent after the project starts, a contractor is in a stronger bargaining position. In either situation, always seek your lawyer’s help.