The Constitutionality of Mechanics Liens, Stop Notices and Bonds

Law Talk

Sam K. Abdulaziz
Attorney at Law

For many years now, there have been articles, litigation, and even Supreme Court decisions dealing with the constitutional right to a mechanic's lien, stop notice or bond. Our office has been heavily involved in this issue, attended numerous meetings and hearings throughout, and have argued the matter extensively. I thought that it might be a good idea to give a shorthand discussion of what has transpired, and where we are today.

It began approximately seven years ago, when a lady in San Jose wanted to have her deck finished. She hired a contractor who did all the work in just one day. He got paid but he did not pay either a supplier or subcontractor. The supplier or subcontractor then recorded a mechanic's lien.

Anyone involved in mechanic's lien litigation will know that there is very little one can do to protect himself/herself from someone recording a lien other than obtaining a bond from the contractor. In this case, the lady did not obtain a bond. Therefore, because the transaction was all done in one day, including the payment to the contractor, the homeowner could do nothing. We are not sure what transpired in that case but it is the factual situation that most recently started the "double payment" problem.

Somehow, the homeowner got to her Legislator in San Jose and the Legislator started to take up the owner's cause. The Legislator sought legislation that he thought would keep this from happening again. Unfortunately for the homeowner, this was not true because the Legislator thought normal legislation would be sufficient to protect owners. He found out that this was not true. He was told that it would take a "super majority" vote in the legislature to make the change. This started a disagreement as to whether it would take a super majority vote to do away with the mechanic's lien right. We had always stated that it was in fact constitutionally protected. The most important case of Clarke v. Safeco made the decision on June 26, 1997, and a rehearing was denied on September 3, 1997. This is a California Supreme Court case.

The Clarke v. Safeco case started off with prime contractors inserting "pay-if-paid" clauses into their contract. Essentially, the "pay-if-paid" clause would say that payment by the owner to the general contractor was a condition precedent to the general contractor's obligations to pay subcontractors. This "pay-if-paid" clause also flowed down to lower tier subs. Other states had held that the "pay-if-paid" clause did not absolutely keep one from paying the amount, but that the subcontractor would have a right to payment within a reasonable period of time. The decisions of the courts would opine that the parties really did not mean that the "pay-if-paid" clause would be that strictly enforced. The court would say that they really did not mean that, but that they meant that payment would be delayed for some period of time. That theory was called a "pay-when-paid" clause rather than "pay-if-paid." This went on for many years. Other courts, such as New York and Wisconsin, take a "pay-when-paid" clause as being a "pay-if-paid" clause. The "pay-if-paid" clauses have been declared void in such places as Illinois, North Carolina, and Wisconsin. This became the issue in the Clarke v. Safeco case. A "pay-if-paid" clause typically reads,

"Receipt of funds by contractor from owner is a condition precedent to the contractor's obligation to pay subcontractor under this agreement, regardless of the reason for owners non-payment, whether attributable to the fault of the owner, contractor, subcontractor, or due to any other cause."

In Clarke v. Safeco, the general contractor, Keller, obtained a labor and material payment bond from Safeco Insurance. This was to protect the owner from mechanic's lien claims from subcontractors and material suppliers.

After substantial work had been completed on the project, the owner stopped making payments to Keller - apparently as a result of the owner's insolvency. Keller then stopped payments to subcontractors who then recorded mechanic's liens and filed separate actions against Safeco under the payment bond. The trial court granted a judgment in favor of the subcontractors and Safeco appealed. All of the cases were then consolidated and the Court of Appeal affirmed each judgment against Safeco.

The bonding company, Safeco, argued that the requirement for the payment bond never matured because the liability of a surety on a private works payment bond is no greater than that of its principal, Keller. Keller never incurred any obligation to pay subcontractors for their work because of the "pay-if-paid" clause.

On the other side, the state constitution provides that,

"Mechanics, persons furnishing materials, artisans, and laborers of every class shall have a lien upon the property upon which they have bestowed labor or furnished material for the value of such labor done and material furnished; and the legislature shall provide by law, for the speedy and efficient enforcement of such liens."

The court stated that the "mechanic's lien" is the only creditors remedy stemming from constitutional command and our courts have "uniformly" classified the mechanic's lien laws as remedial legislation to be liberally construed for the protection of laborers and material men.

The decision goes on to state numerous other provisions that would protect mechanic's lien rights. Four lien waivers (a Conditional Waiver and Release Upon Progress Payment, an Unconditional Waiver and Release Upon Progress Payment, a Conditional Waiver and Release Upon Final Payment, and an Unconditional Waiver and Release Upon Final Payment) were put into law.

The flip side of this is that Civil Code section 3140, limits a subcontractor's recovery on mechanic's lien claims to "such amount as may be due him according to the terms of his contract." Safeco further argued that mechanic's lien remedies are available only to subcontractors whose payment rights have vested under the terms of their contract. As you can see, Safeco is arguing contract rights. Absent a contractual right, no remedy would be available.

Typically, attorneys arguing before the California Supreme Court specialize in such matters. However, in this case, five attorneys, including our office, all argued in favor of the constitutional right of mechanic's liens.

The response of the Supreme Court was that the legislature's carefully articulated anti-waiver scheme would amount to little if the parties to construction contracts could circumvent it by means of the "pay-if-paid" clause.

There were other arguments by Safeco that the "pay-if-paid" subcontracts are void as against public policy. Most of those arguments dealt with "freedom of contract."

At the end, the court concluded that a general contractor's liability to a subcontractor for work performed cannot be made contingent on the owner's payment to the general contractor. Therefore, Keller was liable to the subcontractors under their subcontract for the work that they performed and Safeco, as Keller's surety, was likewise liable on the payment bond.

However, this was a four to three decision and could, in the future, change if the legislature changes it.

Immediately after the decision in the Clarke v. Safeco case, another decision came down from the Appellate Court (one level below the Supreme Court). This case was waiting for the Supreme Court decision dealing with a public works project, because it dealt with the same issues. However, the major difference was that in public works, there is no mechanic's lien right. Public works use stop notices. Therefore, one of the arguments is that there was not a mechanic's lien and therefore no constitutional protection.

The Appellate Court, however, decided that the stop notice was merely a substitute and therefore, was also constitutionally protected.

Since that time, we have been involved in numerous pleadings dealing with the constitutional right to mechanic's liens, stop notices, and bonds. To date, we have been successful in holding off any intrusion. As we sit here today, the right to mechanic's liens, stop notices, and bonds are constitutionally protected.