Lisa Radetsky, Phillips Nizer
Contractors need legal protection to make sure they get paid for their services. They have that with something known as a mechanics lien, which can pose major headaches for co-op and condo boards. Can you explain?
A mechanics lien is statutory protection given to contractors and their suppliers that entitles them to file a lien in the County Clerk's office stating the amount owed for a given job. So this lien has a status of the judgment without trial, which is why it gets in the way for both co-ops and condos in transacting business.
When they file this lien, what is their remedy and how does it affect a building?
After filing, they have a year to go to court and commence a full-scale foreclosure proceeding, just like a bank foreclosure. That creates issues for co-ops and condos on several levels. First of all, the property is at risk. And secondly, ordinary business, like refinancing a mortgage, sales and transfers, are affected because title companies need assurances that it will be paid. So the parties have the right to dispute what's owed. The statute provides that a building or an individual can purchase a bond from a surety company in the amount of 110% of the lien. Then that bond and an affidavit or affirmation stating that a bond is being recorded is given to the county clerk's office. So when the contractor goes to foreclose that lien, they are no longer foreclosing on a property but a monetary obligation.
You have a client who is buying an apartment in a condo that was embroiled in a mechanics lien. Can you tell us about that?
The client contracted to purchase a very expensive apartment, and when we went to close, there were multiple mechanics liens totalling about $500,000 that were not bonded. The work was done on the common elements, so all the unit-owners were responsible for the cost. My client didn't really object to being responsible for his pro-rata share, which was relatively minimal. The problem with his particular case was because he had a new deed going on, it made him especially vulnerable to a foreclosure. The title company was not prepared to write over it and the board did not bond it. So we went round and around with them. In the end, my client negotiated a financial settlement on the theory that if there was a foreclosure, he would start an action to impede the board and get the board to bond. Most of the liens have been paid or settled, but one remains open and not bonded, so this situation is still ongoing.
I believe the board neglected their fiduciary duty to the unit-owners. My client technically had the right to walk because he was entitled to a clean title. If he had chosen to terminate the contract and then the unit-owner went to sell it and got less money, the unit-owner would be entitled to sue the board. And it is likely they would win.
Is a bond the only way a board can protect itself?
There are court procedures to terminate or remove a lien, but they’re time-consuming. My office has been successful in terminating liens that were incorrectly or improperly filed, but it literally takes months to go to court and to wait for an answer. Normally the best thing to do is probably just settle the dispute and pay. But that takes two willing parties. So I would advise a condo board to buy a bond. The cost of the bond is 10% of the lien. That way you can fight with the contractor for as long as you like, and nobody's at risk.
What’s the situation with co-ops?
Iti is a bit different because people don't own their apartments. When a contractor files a mechanics lien, it’s against the entire building. So co-op boards need to be involved and make sure that the proprietary lessee bonds the lien. Shareholders who do significant work generally have an alteration agreement, which also provides to bond the liens. Some agreements say the contractor must waive the right to file a lien, but in my opinion, that's going to be unenforceable. It's contrary to statute.
So what should a solid alteration agreement include vis-a-vis mechanics liens?
It should impose upon the lessee doing the work the obligation to bond any liens of which it receives notice. But generally feuds don't arise before the alteration agreement. They usually arise while the work is in progress or there’s a lack of progress if you will. I mean, I just think a board has to be vigilant. Normally boards take deposits, so that's one way they can at least cover their cost in terms of enforcing the obligations of the alteration agreement. But alteration agreements that try to go further than requiring the shareholder to bond a lien aren’t going to fly, because at the end of the day, when the gavel falls, I don't think judges are going to say a contractor can waive the right to file a lien.
Can you sum up the takeaway, both for condos and co-ops?
For condos, whether a contractor files a mechanics lien against the unit-owner or the against the condo itself for work done in the common elements, the condo board has to be proactive. If they're not going to settle the dispute, which is their prerogative, they need to bond the lien. They need to engage counsel familiar with mechanics liens who has contacts with surety companies to purchase the bond and do the legal work required to file the bond. To not bond a lien puts the board at risk because all purchase contracts provide that a buyer take the apartment lien free. So the day a unit-owner loses their buyer because of the mechanics lien, the board is liable. It breached its fiduciary duty to a unit owner. So I don't see condo boards having a way out.
For condos, the main thing with bonding a line is that they may have more issues posting collateral. But co-ops usually have equity in their buildings, so posting collateral is less of an issue for them. Still, I just think boards are exposing themselves to liability, including personal liability, without a bond. Mechanics liens don’t arise for work done by the corporation, but in the context of a shareholder alteration. So again, I think boards need to be vigilant. Generally boards sign off on the work being completed, but they could put a provision in the alteration agreement that a shareholder has to give evidence that all amounts paid and no liens have been filed before they do so. There is a form where a contractor will certify that they've received everything they’re owed.
So a shareholder doesn’t pay their vendor, the vendor files a lien, and the shareholder still refuses to do anything. Where does that leave a co-op board?
Because the corporation owns real estate, it has the right to purchase a bond and bond the lien. And since standard proprietary leases provide that the shareholder would become responsible for the costs incurred by the board, that would include the cost of the bond, the recording fee, possibly some sort of return on any collateral posted by the board, and obviously the legal fees. The co-op would have the right to collect them against the shareholder under the terms of the proprietary lease.