Amendments to Laws Governing Mechanics' Liens and Stop Orders

CONSTRUCTION LAW

January 2000

Amendments to Laws Governing

Mechanics' Liens and Stop Orders

The new definition of "completion" ... timeline-handout re: calendaring ... filing suits on liens ... suits on stop orders

The following information is reprinted here with the kind permission of Lorman Educational Services.

As we start this morning, I have only 40 minutes in which to acquaint you with a marvelous new remedy for the general contractors, or the subcontractors, with whom we work. I say that I am going to "acquaint you" with this new remedy, the "Stop Order Law," because I have found during the last 18 months that extremely few lawyers have yet "had their hands dirty" with a Stop Order. From talking to construction law practitioners, I have found that only about 15% of them have actually dealt with one of these new Stop Orders since the statute became effective on August 21, 1998. I predict that we are going to see more and more of these Stop Orders as our economy slows down. I think we had better learn how they work.

To put this new remedy in context, let me take you back to the way things were about 10 years ago. In 1990, if you were a subcontractor and had not been paid your 2nd and 3rd payment applications to the General, you had only Choice A or Choice B, the latter with two variations. Choice A was to forget about your lien and file a suit in contract against your contracting party. Choice B was that you could lien the apartment project job for all that you had put into it, your "enhancing" of the owner’s premises, minus whatever you had been paid. Your variation on Choice B then was to leave the job or not to leave the job that you had liened! Your mechanics lien would very likely be behind a whopping big first mortgage which, in those days, was likely to be 95% of the top value of a working apartment project. So, when most of the subs walked off for non-payment and the appraisers moved in so as to value the "pile of sticks and pipes" for the lender, the 5% owner’s equity just "evaporated." You, the sub, now had a lien, but the project (and likely the owner) were headed for bankruptcy or a foreclosure sale.

The first lender would make a credit bid in a foreclosure or a bankruptcy sale of a project and, simply put, no artisan could hope that his lien could bring him any significant sum. In the event that there were to be some "nubbin" of equity left, the fact that the lienor-claimants could not then get an award of their attorneys’ fees would "chew up" the possibility of their recovering much for their liens.

The sub’s only hope was that the project which he was liening was not yet "far gone" economically. If that were the case, the sub could count on some title company spokesperson’s contacting him to say that "everyone else" was settling out for 30% of their claimed lien-amount so as to permit the defunct owner to "sell and transfer free of liens" on the project. If the sub would not cooperate, then 20 other subcontractors would hate his guts for having blocked the only way for them all to get any significant money out of the failed project.

Only "once in a blue moon" would a subcontractor be so lucky as to hear that the project was not as I have described it above. On the best of those occasions, one heard that one’s lien had been "bonded off" with a §32-1004 "150% of lien amount" bond. In such few cases, the lucky sub would be allowed to "chase the cash" represented by the §33-1004 bond – rather than chasing a chance of bidding in at a courthouse-steps auction foreclosure sale or a bankruptcy court sale concerning the title to (the equity in) a troubled apartment project.

In a nutshell, the great expense of preparing, then recording a notice of lien, then suing upon the lien, then fighting off the economic failure of the project, and (likely) the economic failure of the owner, simply made the mechanics lien law an illusory remedy. Having a poor remedy made the subs and generals "easy prey" for an owner’s threatened bankruptcy or a first lien "blowout" foreclosure. The contractors had a bad legal position – and it blighted their business posture.

I do not plan to dwell on how "they" do it in other States, whose laws our Legislature so often looks to when we are making social policy. Suffice it to say that California Civil Code §3103 contained the seeds of what was enacted here in Arizona some 18 months ago in 1998.

The core of the Stop Order is a simple concept: the unpaid contractor ought to be able to chase cash, rather than chase an equity in real estate, equity which is very often just an elusive figment of bankers’ imaginations.

It is, however, crucial for you to understand that the new Stop Order does not apply to two classes of work: (a) to government work (non-"private" work per §33-1053) and (b) to owner-occupant dwellings per §33-1002.

Let’s take those two exclusion areas separately. For government work, the contractors are protected by the Little Miller Act, §34-222. There, the contractors already can chase the cash! As to private owner-occupant residences, subs never even had any lien rights on such residences. A.R.S. §33-1002. Only Generals who had a signed contract with the owner could lien owner-occupant residences. The Legislature was in no mind to extend this new remedy to those two situations, i.e. to the Miller Act covered work nor to the owner-occupant residence.

To understand the new remedy, you need only think of it as sort of a form of "garnishment" designed to help artisans, designed to permit them to "garnish" construction loan funds in the hands of the lender, or the owner. As we will see, this remedy will let the contractor "chase the cash," instead of resorting to his illusory remedy of liening the project and trying to obtain relief from its equity.

Here are the Stop Order Notice ("SON") laws contained in Title 33 of the Arizona Revised Statutes:

(a) Contents of the SON: A stop order notice served on the Owner or Lender must be verified – and it must contain the five items listed in A.R.S. §33-1051: (i) description of the labor, materials, or tools furnished. (ii) the person requesting such. (iii) the value of what was furnished and promised to be furnished. (iv) the amount of payment received. (v) the name and address of the stop order claimant.

As Exhibit B, I have given you a form of Stop Order Notice which is being used today by one of the lien services here in Phoenix. Please note that a copy of the bond should be attached if it is a Bonded Stop Order Notice ("BSON").

You can deliver a stop order notice early in the job, whenever you are unpaid and you want to "garnish" money flowing along the lender-owner-general chain above you so as to be sure that you will get paid. THE KEY IS THAT ONCE YOU SERVE IF YOU FAIL TO SUE UPON YOUR NOTICE BY THREE MONTHS AFTER YOUR LIEN RECORDING PERIOD EXPIRES, then you are too late to sue on your Stop Order Notice. See A.R.S. §33-1063. Once that 90 days period (after the lien recording period) has lapsed, an SON, if you served one, is void and of no effect. §33-1063(B). See Exhibit C, my timeline for SON’s and liens.

Section §33-1058 says that upon receipt of a SON the lender may (and on receipt of a BSON the lender shall) withhold from construction funds the amount needed to pay the claim. What I have found to be a practical problem is that lenders "take their own sweet time" in telling the party serving the SON or BSON whether or not the lender had some funds available which have been "trapped" by the service of the SON or BSON. I believe that the reason that lenders are often slow to admit that funds have been reached and segregated is that they are not sure if 10 more SON’s might be coming in to them and, if so, what money will be available to cover all the SON’s eventually received.

(c) Bonding: As you all may know, if you serve a prejudgment garnishment, you have to provide a bond against the risk that yours might be a wrongful garnishment.

Well, in much the same vein, to have an automatic "garnishment" result from a contractor’s service of a SON, it has to be a bonded SON ("BSON") that one serves. See §33-1058. The bonds, by the way, seem to be really cheap.

I sometimes have to "pinch myself" regarding the unbonded stop orders. I rather wonder why one would "bother" serving an unbonded stop order notice. As is made clear in A.R.S. §33-1058(A), an unbonded notice is like a "letter to mom." The lender, if he wishes, can ignore it and continue using up loan funds. However, I can imagine few instances where lenders, whose fees and interest after all are paid by the owners, will, out of the goodness of their hearts, elect to "recognize" an unbonded stop order notice and proceed to withhold loan funds to cover the stop order claim by a subcontractor.

(d) Service: Under §33-1056, there are strict requirements on how one serves an owner (personally, or through substituted service made on someone living at his residence). There’s no indication of what you do when the owner is a corporation or an LLC. There are, likewise, strict requirements about serving a lender; you must serve the Manager or "other responsible officer" at the branch or the office of the Lender that actually manages the construction monies in question. If you are calling around to get that information from the lender, you will want to keep a record as to who on the lender’s staff told you it was the North Sunnyslope office or who the manager there was.

Well, no one would expect that the contractors could get this dandy new remedy without there being some "buried hazards" placed inside the statute.

If you were a lender, you would like to be able to process the payments on a troubled construction job in such a way that you could know at given intervals that you had the fund-flow "under control." You would want to be able to project what SON’s might do to your fund balance. If you were a lender, you would not want last minute SON’s from six contractors, for three months of payment applications each to hit you suddenly when the job (and the funds for the job) were nearly at completion. The way that the lenders can do that testing of the financial status of the job is by what I call "periodic sweeps."

In §33-1054 and in §33-1055(A), it states that any owner or lender can send out to a contractor a "DEMAND FOR SERVICE OF STOP NOTICE PURSUANT TO A.R.S. §33-1054 and 1055." The owner or lender’s bold-faced typed message to your contractor clients should be a "red-flag" whenever such a notice comes in the mail. If the contractor fails to respond by serving on the lender a stop order notice by the 30th day after the mailing to him, then he cannot later serve any stop order notice for "the work" which the owner described in the owner’s "demand for stop notice." Thus, I predict that when lenders get down close to the last installment of their construction loan pay-out, they will routinely send out these "sweep" demands for stop orders. If you respond, then they know exactly what debts exist that may lay claim on their funds. If you don’t respond, they can safely ignore you as regards the project’s loan funds. Uneducated contractors will carelessly lose their chance to "chase the cash," leaving those contractors with just their lien remedies.

(a) If a rash of stop order notices hits a lender, it does not mean that the first to serve gets 100% and that other later claimants may get 50% or zero. Under §33-1060, all stop order claimants will receive a pro-rata share. In other words, stop order notice claimants are put on a "parity" and the "garnished funds" are doled out in pro rata shares. See A.R.S. §33-1000. It is this vague feature, I believe, of the SON law that slows down lender responses to SON’s.

(b) Rather like §33-420 regarding false liens, §33-1061 says that the contractor who willfully serves a false stop order notice, will be subjected to severe penalties. He forfeits all lien rights, all stop order "garnishment" rights, and he gets hit with §33-420’s $5,000 or actual damages, which ever is greater!

(c) Note that there are really three responses that a contractor might receive from a lender after service of a BSON: (i) "we got your notice and bond and we have segregated and are holding all the funds which you claimed"; (ii) "too late, when your notice reached us, we had paid out so much of the loan proceeds that we now hold nothing (or a very small portion) of what you claimed"; or (iii) "hallelujah, there is a §33-1003 bond in lieu of liens recorded on this job – and we are refusing your BSON because you can go chase that cash." See §33-1057(B).

You will be pleased to learn that, similar to §33-998, allowing attorneys’ fees in lien-foreclosure suits, the new stop order law has provided for attorneys’ fees awards in its §33-1066. There is also a separate interest provision related to funds trapped by a BSON, so as to discourage lenders from holding such trapped funds for long periods.

Final Comments on the "Interplay" between Lien Laws and the Stop Order Notice

No longer does the subcontractor who fears the general contractor’s shaky finances, have to worry that, when the General "goes down," the sub will be caught up in a lien-enforcement game in which the sub can only rarely win payment for what he’s actually spent on the job. No longer does the sub have to chase the equity in the troubled project, knowing all the time that it is an illusory pursuit.

The new stop order notice remedy allows a sub (or a General) on a troubled project to chase the cash by serving the owner or lender with BSON’s which act somewhat like bonded prejudgment garnishments of construction loan funds. This new remedy can accelerate the subs (or a General’s) getting paid. The new remedy is timed so that, if one watches the timeline, Exhibit C, one can "test the waters" by serving bonded stop order notices; see if one gets a favorable response from the "garnished party"; see if payment in full is received before the lien period expires; record one’s lien while then commencing suit upon a BSON; and seek to foreclose that lien if the pro-rata share of a construction loan’s proceeds remaining does not cover 100% of the value which one has put into the job.

In a nutshell, the BSON remedy is speedier, more reliable, and, since it’s a "chase of the cash," it is likely to benefit the contractors far more than a lien claim.

The lien remedy then remains as a "backup" remedy, one that can supplement the BSON remedy, if one has commenced so late in the process that loan proceeds are essentially exhausted before the BSON’s reach the lender.

All contractors need to be vigilant in scanning their mail for a §33-1054 and 1055 "Demand for Service of Stop Notice pursuant to A.R.S. §33-1054 or 1055." To fail to timely respond (in 30 days) is to abandon all possibility of using stop order notices on that job.

These materials are designed to provide general information prepared by professionals in regard to the subject matter covered. It is provided with the understanding that the author is not engaged in rendering legal, accounting, or other professional service. Although prepared by professionals, these materials should not be utilized as a substitute for professional service in specific situations. If legal advice or other expert assistance is required, the service of a professional should be sought.