A lien discharge bond assures your mechanic’s lien will be paid, doesn’t it?

Usually a surety posting a lien discharge bond, insures payment of your mechanic’s lien, but not always. A contractor who records a mechanic’s lien for amounts it is owed is thrilled when the owner or person with whom they contracted records a lien discharge bond. The recording of the bond transfers the lien from the real property to the bond posted by an insurance company.

Recently, the Arizona Court of Appeals ruled in RLI Insurance v. National Construction and Development that a surety was not required to arbitrate and, by extension, likely was not obligated on the lien discharge bond.

National Construction and Development (“NCD”) had a construction contract with the property owner – Robert Pulver, to remodel a parking lot in Fort Mohave, Arizona. The construction contract (“Contract”) between NCD and Pulver contained an arbitration clause requiring any dispute or claim related to or arising from the Contract, its performance, breach, interpretation, validity, or enforceability to be arbitrated with the American Arbitration Association (“AAA”). NCD completed the project and invoiced Pulver, who didn’t pay. 

NCD recorded a mechanic’s lien with the Mohave County recorder’s office and filed a demand for arbitration with AAA to, among other things, foreclose NCD’s mechanic’s lien.

Pulver obtained a lien discharge bond from RLI pursuant to A.R.S § 33-1004 and recorded the lien discharge bond in Mohave County, thereby discharging the lien against Pulver’s real property with the lien discharge bond as replacement security.

RLI was not a signatory to the Contract between Pulver and NCD. NCD added RLI to the AAA arbitration as a party respondent. In response, RLI filed a complaint in Mohave County Superior Court claiming that NCD failed to timely perfect its lien and a determination that RLI was not bound by the arbitration provision in the NCD/Pulver Contract.

NCD argued that RLI was “stepping in” as surety under the lien discharge bond and consequently “binding itself to pay outstanding obligations alleged to be owed” by its principal, Pulver. Claiming, therefore, that RLI also became bound by the mandatory arbitration provisions of the NCD/Pulver Contract. Furthermore, Arizona statutes require adding the surety who posted the lien-discharge bond as a party to the lawsuit against Pulver. NCD argued it met the six-month limit to foreclose its lien by timely initiating arbitration with AAA.

It was undisputed that RLI was not a signatory to the Contract between NCD and Pulver. A non-signatory to an agreement to arbitrate may be bound to arbitrate when equitable estoppel, assumption, agency, third-party beneficiary, veil-piercing, or alter ego exist. However, none of those factors existed in the case. Therefore, on the record before the court of appeals, RLI was not bound to arbitrate under statute or common law.      

A.R.S § 33-1004(B) required NCD to add RLI as surety to a pending action to foreclose its mechanic’s lien within 90 days of RLI recording the lien discharge bond. A lien discharge bond is a security mechanism governed by statute and binds the issuer to satisfy amounts encompassed in a mechanic’s lien.  

According to the court, RLI “stepping in” as surety by statute does not bind RLI to the arbitration requirement contained in the NCD/Pulver Contract.     

The court also noted the lien amount may or may not correlate to amounts owed under Contract – a lien is merely a method to secure payment and is distinct from the obligation it secures. A lien is a statutory remedy that stands apart from the remedy under the NCD/Pulver Contract.

The initial distinctions between lien rights and construction contracts do not dissolve when an owner of a burdened property posts a surety bond. Rather, the property itself is freed of the lien burden, and the surety assumes the burden through the bond.     

The law governing mechanic’s liens establishes that lien rights are distinct from any contract obligations that may or may not exist, and statutes governing a surety’s responsibilities under a lien-discharge bond do not erase those distinctions. These statutes do not bind RLI to obligations arising under a construction contract between the bond’s principal (Pulver) and the lien claimant (NCD).       

The court of appeals vacated the superior court decision and remanded the case to enter an order consistent with A.R.S. § 12-3007(B) that RLI is not bound to arbitrate and proceed with RLI’s lawsuit for declaratory relief regarding the validity of NCD’s mechanic’s lien.        

The practice pointers from this case are that sureties who post a lien discharge bond are not bound by the mandatory arbitration provision it the construction contract between the contractor and bond principal, in this case, Pulver. It also now requires a lien claimant subject to a mandatory arbitration provision to BOTH timely demand arbitration and separately and timely file a lien foreclosure lawsuit in the country where the mechanic’s lien was recorded. Recent U.S. Supreme Court precedent (Smith v. Spizzirri 601 U.S. 472 (2024) authorizes staying the superior court lawsuit while the parties arbitrate their dispute.