Construction Lending:

Transcription

1 Self Study Paper For: The 25 th Annual Robert C. Sneed Texas Land Title Institute San Antonio December 3 4, 2015 Construction Lending: Mechanic s Liens and How They Work Andrea Alford Hight Andrea Alford Hight Winstead PC Dallas, Texas AHight@winstead.com

2 TABLE OF CONTENTS Page I. INTRODUCTION... 1 II. BACKGROUND... 1 A. Who Is Entitled to a Lien Persons Furnishing Labor Persons Furnishing Materials Nature of the Improvements... 2 B. What Does a Lien Claim Secure... 3 III. ORIGINAL CONTRACTOR LIEN... 4 A. Constitutional Lien... 4 B. Original Contractor's Statutory Lien... 5 C. Sham Contractor StatuteProperty... 5 IV. SUBCONTRACTOR'S STATUTORY LIEN... 5 A. Types of Subcontractor Liens Fund Trapping Lien Statutory Retainage Lien... 7 B. Procedures for Perfecting Liens Notice of Claim: First Tier Subcontractors/Suppliers Notice of Claim: Second Tier Subcontractors/Suppliers... 9 V. THE MECHANIC S LIEN AFFIDAVIT... 9 A. Time for Filing Affidavits Original Contractor Lien Fund Trapping Lien Statutory Retainage Lien Claim for Contractual Retainage Specially Fabricated Materials B. Contents of Lien Affidavit C. Notice of Filed Affidavit VI. LIEN PRIORITY A. To What Property Does a Lien Attach B. Inception of the Mechanic's Lien The Relation Back Doctrine The Relation Back Doctrine Establishing the Commencement of Construction C. Removable Property i

3 1. Who May Assert a Claim To Removables What Is a Removable D. Liens on Leasehold Improvements E. Priorities and Preferences Amongst Mechanic's Lien Claimants VII. PROTECTING THE PROPERTY AGAINST LIENS A. Statutory Payment Bond B. Contractual Subordination of Lien Rights C. Interim and Final Lien Waivers D. Bills Paid Affidavit ii

4 CONSTRUCTION LENDING: MECHANIC'S LIENS AND HOW THEY WORK I. INTRODUCTION This paper will provide a general overview of the Texas mechanic's and materialman's lien (i.e., "mechanic's lien") laws as they relate to commercial private projects and tips on how to protect title to the property. II. BACKGROUND Since the days of the Republic of Texas, persons furnishing labor or materials for the construction or repair of improvements to real property have been granted the right to claim a lien on the real property and the improvements thereon to secure payment for their work. Currently, a wide range of persons performing work in connection with improvements to real property can secure lien rights against the real property and improvements thereon. Article XVI, Section 37 of the Texas Constitution provides that "mechanics, artisans and material men, of every class, shall have a lien upon the buildings and articles made or repaired by them for the value of their labor done thereon, or material furnished therefor...". While the constitutional lien appears to extend only to the building itself case law has made it clear that the lien extends to the land necessary for the enjoyment of the building or necessarily connected therewith. Strang v. Pray, 35 S.W (Tex. 1896); Farmers' & Mechanics' Nat'l Bank v. Taylor, 40 S.W. 876 (Tex. Civ. App. Ft. Worth 1897), aff'd, 40 S.W. 966 (Tex. 1897). The constitution further directs the legislature to "provide by law for the speedy and efficient enforcement of said liens." TEX. CONST. art. XVI, 37. The Texas Legislature's response to this constitutional mandate is Chapter 53 of the Texas Property Code. While mechanic's lien rights are significant, they are also somewhat limited. For example, mechanic's liens can only be enforced through judicial foreclosure. Because of the time and expense of litigation and the adverse consequences for the owner when the mechanic s lien is foreclosed, judicial foreclosures of mechanic's liens rarely occur. However, the perfection of a mechanic s lien claim against an owner's property often gives the claimant significant leverage in negotiating and resolving payment disputes. In fact, this leverage is the primary benefit of a mechanic's lien to a claimant; however, the leverage exists only when the mechanic s lien claim is properly perfected. A. WHO IS ENTITLED TO A LIEN Generally, anyone who furnishes labor or material for the construction or repair of a house, building or improvements to privately owned real property in Texas is entitled to perfect a mechanic's lien. TEX. PROP. CODE , et seq. 1. Persons Furnishing Labor The labor must be used in the "direct prosecution" of the work. 1 Id. at (3). Consequently, "indirect" work such as providing legal services in connection with a project or furnishing meals to 1 Temporary labor providers and employee leasing companies frequently furnish labor to construction projects. Provided that the temporary or leased workers are employees of the temporary labor provider or employee leasing company (i.e., the temporary labor provider or employee leasing company is the party responsible for the workers' pay and related benefits), then the temporary labor provider or employee leasing company is entitled to perfect a lien claim for the unpaid value of the "labor" it furnished through its employees to the project. Reliance Nat'l Indem. v. Advance'd Temps., 227 S.W.3d 46 (Tex. 2007). 1

5 workers is not covered. Am. Sur. Co. v. Stuart, 151 S.W.2d 886, 887 (Tex. Civ. App. Fort Worth 1941, no writ); Van Horn Trading Co. v. Day, 148 S.W (Tex. Civ. App. San Antonio 1912, no writ). Under the statute, architects, engineers, and surveyors are entitled to a lien for the preparation of plans or drawings in connection with the actual or proposed design, construction, or repair of improvements to real property. The work must be "under or by virtue of a written contract with the owner or the owner's agent." TEX. PROP. CODE (c). The lien for design services has its inception from the date the lien affidavit is recorded (i.e., it does not "relate back" to the commencement of construction). 2. Persons Furnishing Materials Additionally, persons (individuals, partnerships, and corporations) who furnish materials for the construction or repair of improvements are entitled to file and perfect a lien under the Property Code. TEX. PROP. CODE "Materials" is defined to include materials, machinery, fixtures, and tools which are consumed in the construction or which are ordered and delivered for incorporation or consumption. The definition also includes reasonable rent for equipment used or reasonably required and delivered for use in the direct prosecution of the work at the construction site. Id. at (4). "Plant materials" and "landscaping supplies" are covered as well. Id. at (d). The materials must be "furnished" to the project. This does not necessarily mean delivery to the project site. A claimant is entitled to secure a mechanic s lien even if the claimant is unable to prove that the materials in question ever made it to the project site, so long as the materials were delivered to the owner or the general contractor for the specific project. See Trammell v. Mount, 4 S.W. 377, (Tex. 1887); Lexcon Inc. v. Gray, 740 S.W.2d 83 (Tex. App. Dallas 1987, no writ); Addison Urban Dev. Partners, LLC v. Alan Ritchey Materials Co., 437 S.W.3d 597 (Tex. App. Dallas 2014, no pet.). Similarly, a claimant does not have to prove that the materials were actually incorporated into the work so long as the claimant can prove delivery to the owner or contractor for the project. See W. L. MacAtee & Sons, Inc. v. House, 153 S.W.2d 460 (Tex. 1941); Sheldon Pollack Corp. v. Pioneer Concrete of Texas, Inc., 765 S.W.2d 843, (Tex. App. Dallas 1989, writ denied). As one court has noted, "[i]t appears... that the fact that material is furnished to a builder for the purpose of use on a particular job is as a general rule the controlling consideration in determining the materialman's right to a lien." Houston Fire and Cas. Ins. Co. v. Hales, 279 S.W.2d 389, 392 (Tex. Civ. App. Eastland 1955, writ ref'd n.r.e.). 3. Nature of the Improvements The labor or materials must be furnished for the repair or construction of a house, building or "improvements." Improvements include: (i) abutting sidewalks and streets, as well as utilities in or on those sidewalks and streets; (ii) wells, cisterns, tanks or reservoirs for storing water; (iii) pumps, windmills and other machinery for raising water; and (iv) orchard trees (planting, grubbing, replacing, and pruning). TEX. PROP. CODE (2)(A)-(E). The definition of "improvement" for which a lien may be secured expressly includes clearing, grubbing, draining, or fencing of land and planting, grubbing, replacing, and pruning orchard trees. Id. at (2)(B), (E). This definition includes some but not all types of landscaping services that are commonly performed on construction projects. Under section (d) of the Property Code, persons who perform labor or furnish plant materials and other supplies for the installation of landscaping including the construction of retention ponds, retaining walls, berms, irrigation systems, and fountains may file a mechanic's lien. As with the lien for design services, the landscaping work must be furnished "under or by virtue of a written contract with the owner or the owner's agent." Id. at (d). Further, a lien for landscaping services has its inception from the date the mechanic s lien affidavit is recorded (i.e., it does not "relate back" to the commencement of construction). 2

6 Because mechanic's liens are intended to provide security for payment to those who "improve" real property (i.e., those who "repair" or "construct" houses, buildings, or improvements to real property), earlier case law held that a person who entered into a contract for the removal or demolition of structures or improvements would not be entitled to secure a mechanic's lien. Big Three Welding Equip. Co. v. Crutcher, Rolfs, Cummings, Inc., 229 S.W.2d 600, 603 (Tex. 1950). In 2003, the Legislature amended section of the Property Code to authorize a person who provides labor or materials for the demolition of a structure on real property to perfect a mechanic's lien. As with the lien for design work and the mechanic s lien for landscaping services and materials, the lien for demolition has its inception from the date the lien affidavit is recorded (i.e., it does not "relate back" to the commencement of construction). TEX. PROP. CODE However, unlike the statutory provisions entitling design and landscaping mechanic s liens, demolition work may be furnished "under or by virtue of a written contract with the owner of the property or the owner's agent, trustee, receiver, contractor, or subcontractor." Id. at (e). Accordingly, subcontractors performing demolition work will be entitled to file a mechanic s lien. B. WHAT DOES A LIEN CLAIM SECURE Mechanic's liens secure debts. The debt covered by the mechanic's lien is limited to payment due for labor performed and materials furnished for the repair or construction of improvements to privately owned real property. Accordingly, when a contractor has a "cost-plus" contract (one in which the contractor is entitled to payment of the subcontract costs plus the contractor's fee), the contractor's mechanic's lien will cover the payment due for both the subcontract costs and the contractor's fee for work performed. Stricklin v. Sw. Reserve Life Ins. Co., 234 S.W.2d 439, 442 (Tex. Civ. App Texarkana 1950). Additionally, sales tax incurred by the claimant for work performed on the project is covered by the mechanic's lien. First Nat'l Bank in Dallas v. Whirlpool Corp., 517 S.W.2d 262, (Tex. 1974). On the other hand, items which may be owed to the contractor but which are not covered by the mechanic's lien would include the following: (i) Unearned or lost profits, such as those arising from a wrongful termination. See Nixon Constr. Co. v. Downs, 441 S.W.2d 284, (Tex. Civ. App. Houston 1969, no writ); but see San Antonio Credit Union v. O'Connor, 115 S.W.3d 82, (Tex. App. San Antonio 2003, pet. denied) 2 ; (ii) Attorney's fees incurred in connection with the project or the collection of the claim (notwithstanding the fact that the mechanic's lien statute provides for the recovery of attorney's fees in litigation relating to the enforcement of a lien). Dossman v. Nat'l Loan Inv'rs, L.P., 845 S.W.2d 384, (Tex. App. Houston [1st Dist.] 1992, writ denied); and 2 The court of appeals in the San Antonio Credit Union decision upheld a trial court judgment ordering the foreclosure of a constitutional mechanic's lien which was based solely upon the jury's finding of "damages" for the owner's failure to comply with the construction contract. 115 S.W.3d at 107. The court of appeals rejected the defendants' argument that a special issue should have asked for the amount of the unpaid value of the services and/or materials furnished by the claimant and held that, since the "constitutional lien" was "self-executing," no proof other than the "existence of the debt" was necessary in order for the trial court to order foreclosure. Id. In doing so, the court of appeals failed to understand that the "damages" for breach of contract might well have included amounts that were not secured and recoverable under the constitutional lien. Unfortunately, in the subsequent appeal to the Texas Supreme Court, the defendants did not challenge this holding (no petition for review was filed by the defendants). 3

7 (iii) Prejudgment interest on the debt (as with the attorney's fees, notwithstanding the fact that it is a recoverable obligation). Ambassador Dev. Corp. v. Valdez, 791 S.W.2d 612 (Tex. App. Fort Worth 1990, no writ); but see San Antonio Credit Union, 115 S.W.3d at III. ORIGINAL CONTRACTOR LIEN A. CONSTITUTIONAL LIEN Art. 16, Sec. 37 of the Texas Constitution provides for mechanic's and materialman's liens as follows: Mechanics, artisans and material men, of every class, shall have a lien upon the buildings and articles made or repaired by them for the value of their labor done thereon, or material furnished therefor; and the Legislature shall provide by law for the speedy and efficient enforcement of said liens. The lien which arises under the Texas Constitution is self-executing and is available only to those who have a contract with the owner (i.e., an "original contractor"). Berger Eng'g Co. v. Vill. Casuals, Inc., 576 S.W.2d 649, 652 (Tex. Civ. App. Beaumont 1978, no writ). However, it is possible that a subcontractor may, in certain circumstances, take advantage of the sham contract provision of section of the Texas Property Code (discussed below) to be elevated to the status of an original contractor. Trinity Drywall Sys., LLC v. TOKA Gen. Contractors, Ltd., 416 S.W.3d 201 (Tex. App. El Paso 2013, no pet.). Since the lien under Texas Constitution is self-executing, the contractor does not have to comply with the notice provisions of the Property Code to enforce the lien against the owner. Huttig Sash & Door Co. v. Stitt, 218 F. 1, 4-6 (5th Cir. 1914); Robert Burns Concrete Contractors, Inc. v. Norman, 561 S.W.2d 614, 617 (Tex. Civ. App. Tyler 1978, writ ref'd n.r.e.). However, the constitutional lien is not valid against subsequent purchasers of the property or lenders taking a security interest in the property who acquire the interest in the property without actual or constructive notice of the lien claim. Wood v. Barnes, 420 S.W.2d 425, 429 (Tex. Civ. App. Dallas 1967, writ ref'd n.r.e.). Constructive notice can be achieved by properly perfecting the statutory lien claim; however, the claimant must fully comply with the statutory requirements in order for the lien claim to provide constructive notice. Dee's Cabinet Shop, Inc. v. Weber, 562 S.W.2d 945 (Tex. Civ. App. Fort Worth 1978, no writ); Detering Co. v. Green, 989 S.W.2d 479, 481 (Tex. App. Houston [1st Dist.] 1999, pet. denied). On the other hand, actual notice rests on "personal information or knowledge." Madison v. Gordon, 39 S.W.3d 604, 606 (Tex. 2001); Tex. Wood Mill Cabinets, Inc., 117 S.W.3d 98, 106. Actual notice can arise not only from actual notice of the lien claim, but from the knowledge of facts that put a "prudent man upon inquiry." Coll. Park Elec. Belt Line v. Ide, 40 S.W. 64, 66 (Tex. Civ. App. Dallas 1897), writ dism'd w.o.j., 39 S.W Accordingly, a subsequent purchaser of the property may have "actual" knowledge of the lien claim if the purchaser is aware of improvements being made on the property "at or shortly before the time the subsequent purchaser took possession of the property." Tex. Wood Mill Cabinets, 117 S.W.3d at 105; Contract Sales Co. v. Skaggs, 612 S.W.2d 652, 653 (Tex. Civ. App. Dallas 1981, no writ); Inman v. Clark, 485 S.W.2d 372, 374 (Tex. Civ. App. Houston [1st Dist.] 1972, no writ); but cf. Detering Co. v. Green, 989 S.W.2d 479, 482 (holding that the current owner did not have actual notice of a claimant's constitutional lien when the property in question was sold by the lender at a foreclosure sale after the completion of the 3 As noted in the immediately preceding footnote, the court of appeals in the San Antonio Credit Union decision upheld a trial court judgment ordering the foreclosure of a constitutional mechanic's lien. The amount of the lien included the prejudgment interest on the amount of the underlying claim. 115 S.W.3d at 107. There was no discussion whether the inclusion of prejudgment interest was proper. 4

8 construction of improvements and the purchaser at the foreclosure sale, in turn, sold the property approximately one year later to the current owner). The burden is on the subsequent purchaser (or lender) to show that it had neither actual notice of the lien claim, nor notice of facts putting it on inquiry concerning the lien claim. Hill v. The Praetorians, 219 S.W.2d 564 (Tex. Civ. App. Waco 1949, writ ref'd n.r.e.); Contract Sales Co., 612 S.W.2d at 653. The existence of actual notice is a question of fact. Coll. Park Elec. Belt Line v. Ide, 40 S.W. 64, 66 (Tex. Civ. App. Dallas 1897), writ dism'd w.o.j., 39 S.W B. ORIGINAL CONTRACTOR'S STATUTORY LIEN In order to perfect a statutory mechanic's lien, an original contractor must file an affidavit not later than the fifteenth (15th) day of the fourth (4th) month following the month in which the original contract has been materially breached or terminated, completed, finally settled, or abandoned. TEX. PROP. CODE (a). The contractor also must mail a copy of the lien affidavit to the owner within five (5) calendar days after the date the affidavit was filed of record. Id. at No additional notices need to be sent by the original contractor in order to perfect a mechanic's lien. C. SHAM CONTRACTOR STATUTE Section of the Property Code is known as the "Sham Contract Statute" and generally provides that a subcontractor will obtain original contractor status for lien purposes if the claimant can show that the owner owns or is in a position to exercise certain control over the original contractor or vice versa (i.e., the contractor owns or can control the owner). Although intended to protect subcontractors from "shams" and frauds, this statute can be used effectively to improve the lien position of subcontractors on projects even when the relationship between the owner and general contractor was never intended to be fraudulent or deceptive. See Da-Col Paint, 517 S.W.2d at An example would be the case of a limited partnership that owns real property using its general partner (or an affiliate) as the original contractor. While the general partner would technically be the original contractor on the project, those subcontractors and suppliers dealing with that original contractor will actually be deemed "original contractors" for purposes of determining lien perfection. Consequently, even though a claimant may fail to send the timely notices required to perfect a subcontractor's lien, the claimant may be able to perfect an original contractor's statutory lien if the party with whom the claimant contracted is deemed the owner under the Sham Contract Statute. Although a claimant dealing with an owner and "sham contractor" may consider these two entities as a single entity for purposes of providing notice and perfecting lien rights under the mechanic's lien statute, the Sham Contract Statute does not change Texas law with regard to alter ego liability. Consequently, an owner contracting with a sham contractor is not deemed to have contracted directly with that subcontractor absent a showing of actual fraud and direct personal benefit or some other basis of alter ego liability. Therefore, a judgment against the contractor for money damages may not be enforceable against the owner simply because of the Sham Contract Statute. Sw. Props., L.P. v. Lite-Dec of Texas, Inc., 989 S.W.2d 69, 72 (Tex. App. San Antonio 1998, pet. denied). IV. SUBCONTRACTOR'S STATUTORY LIEN A. TYPES OF SUBCONTRACTOR LIENS There are only two ways in which a "derivative" claimant (a subcontractor or supplier who does not contract directly with the owner) can obtain a valid mechanic s lien: either by (i) perfecting a "fund 5

9 trapping" lien, or (ii) perfecting a lien on statutory retainage. 4 First Nat'l Bank in Graham v. Sledge, 653 S.W.2d 283, 286 (Tex. 1983); Bond v. Kagan-Edelman Enters., 985 S.W.2d 253, (Tex. App. Houston [1st Dist.] 1999), rev'd in part on other grounds and pet. denied in part, 20 S.W.3d 706 (Tex. 2000). 1. Fund Trapping Lien An owner is required to withhold payments to an original contractor when it receives a written notice from a claimant that contains a special statutory "fund trapping" warning. Hunt Developers, Inc. v. W. Steel Co., 409 S.W.2d 443 (Tex. Civ. App. Corpus Christi 1966, no writ). The legal effect of a timely and properly worded notice of claim by a subcontractor or supplier to the owner is to "trap" funds that are due the original contractor and in the hands of the owner. 5 First Nat'l Bank in Graham, 653 S.W.2d at Accordingly, if the owner pays any money to the original contractor after receiving the fund trapping notice from the claimant without withholding sufficient funds to cover the claim, then the owner will be liable and the property being improved will be subject to a lien to the extent of the money subsequently paid to the contractor that should have been withheld pursuant to the fund trapping notice. Bond, 985 S.W.2d at 259. In order to comply with the "statutory warning" requirement for fund trapping, the notice letter must state that if the bill remains unpaid, the owner may be personally liable and his property subjected to a lien unless the owner withholds payment from the original contractor for the payment of such statement or unless it is otherwise "paid or settled." TEX. PROP. CODE (d), (e). If a claimant fails to furnish an owner with timely notice containing the statutory warning there will be no "fund trapping," and the derivative claimant will not be entitled to a mechanic s lien on the owner's property. Trinity Universal Ins. Co. v. Palmer, 412 S.W.2d 691, 693 (Tex. Civ. App. San Antonio 1967, writ ref'd n.r.e.). Further, because the owner's liability to subcontractors asserting a "fund trapping" lien derives solely from the owner's liability to the original contractor for unpaid contract funds, if the original contractor has already been paid when the owner receives the fund trapping notice letter then the claimant will not be entitled to a valid fund trapping lien. Marek v. Goyen, 346 S.W.2d 926, 928 (Tex. Civ. App. Houston 1961, no writ). Similarly, if the original contractor defaults or abandons the project, the owner can use the unpaid contract funds (even to the extent that the claimant has "trapped" those funds) to complete the original contractor's work. Lennox Indus., Inc. v. Phi Kappa Sigma Educ. & Bldg. Ass'n, 430 S.W.2d 404, (Tex. Civ. App. Austin 1968, no writ). Under section of the Property Code, an owner is required to retain the funds withheld until the time for filing the claimant's affidavit of mechanic's lien has passed or, if the lien affidavit is timely filed, until the lien claim has been satisfied or released. If the claimant makes written demand upon the owner for payment, with a copy to the original contractor, and the contractor fails to dispute the claim within thirty (30) days after receipt of the demand, the contractor is considered to have "assented to the demand," and the owner is directed to make payment to the claimant. TEX. PROP. CODE While there are only two types of statutory subcontractor liens, a claimant may perfect one or both of those liens by means of the notice of specially fabricated materials or the notice of contractual retainage. These are not types of liens rather, they involve specific types of notices which allow the claimant to perfect a lien on contract funds (fund trapping) or statutory retainage in special situations. 5 An owner is relieved of the obligation to withhold "trapped funds" whenever the owner obtains and files a statutory payment bond in compliance with Texas Property Code

10 2. Statutory Retainage Lien An owner is required to retain ten percent (10%) of the contract amount (or value of the work then completed) during the course of construction and for thirty (30) days following completion of the work under the original contract or termination of the contractor. TEX. PROP. CODE The obligation to retain contract funds is commonly known as "statutory retainage." This required retainage creates a fund for the benefit of claimants who have (i) filed lien affidavits within thirty (30) days after the earlier of the date the work under the original contract was completed or the date the original contract was terminated or was abandoned by the contractor and (ii) sent the required notices. TEX. PROP. CODE The fund trapping warning language is not required in the notices to the owner in order to obtain a lien on the statutory retainage. Indus. Indem. Co. v. Zack Burkett Co., 677 S.W.2d 493, 495 (Tex. 1984). An owner and his property are liable to perfected mechanic s lien claimants at least to the extent of the amount that should have been retained if the owner fails or refuses to withhold the full statutory retainage in accordance with section of the Property Code. TEX. PROP. CODE ; see also Gen. Air Conditioning Co. v. Third Ward Church of Christ, 426 S.W.2d 541, 544 (Tex. 1968). The 10% retainage requirement is not, however, applicable if there is a statutory payment bond. Indus. Indem., 677 S.W.2d at 495. A question sometimes arises concerning the extent of the owner's liability for claims which exceed the 10% statutory retainage. In Ambassador Dev. Corp. v. Valdez, the owner took the position that its liability was limited to the 10% statutory retainage it had withheld and that it was not obligated to withhold any additional money when it received a claimant's fund trapping letter because the claimant's claim was less than the 10% retainage being withheld. 791 S.W.2d 612 (Tex. App. Ft. Worth 1990, no writ). The court rejected that argument and held that the owner was required to withhold, over and above the 10% retainage, the amount claimed in the fund trapping letter. Id. at 622. Therefore, the fund trapping notice and the statutory retainage are two separate sources of recovery for claimants, and the owner's liability extends to the amount claimed in the fund trapping letter and the 10% statutory retainage. Another question arises as to how long the owner must retain the statutory retainage. Most industry form construction contracts call for retainage to be paid at substantial completion of the work, less some hold-back for punchlist work. However, section of the Property Code requires the full 10% retainage to be withheld for thirty (30) days following "completion" not "substantial completion" of the work. Section (15) of the Property Code defines "completion" of an original contract as "the actual completion of the work, including any extras or change orders reasonably required or contemplated under the original contract, other than warranty work or replacement or repair of the work performed under the contract." Accordingly, if the retainage is paid at "substantial completion," the owner will be at risk, to the extent of the statutory retainage not withheld, to those claimants who properly perfect their mechanic s lien claims. Hunt Cty. Lumber, Inc. v. Hunt-Collin Elec. Coop, Inc., 749 S.W.2d 179, 182 (Tex. App. Dallas 1988, writ denied); Sixty-Seven Props. v. Cutsinger Elec. Constr., Inc., 536 S.W.2d 268, (Tex. Civ. App. Corpus Christi 1976, no writ). Unlike with a "fund trapping" claim, the owner's obligation to retain statutory retainage is not derivative of its liability to the contractor for unpaid contract funds. Subchapter E of Chapter 53 of the Property Code guarantees a fund in the amount of 10% of the contract price (or the completed value of the work under the original contract) to be available to mechanic s lien claimants that comply with the requirements for perfecting a statutory retainage lien. See TEX. PROP. CODE Accordingly, if a contractor abandons or defaults on the project, the owner may not use the statutory retainage funds to complete the contractor's work. Dowdy v. Hale Supply Co., 498 S.W.2d 716, (Tex. Civ. App. Fort Worth 1973, no writ). 7

11 When there are multiple original contractors on a project a question sometimes arises as to what rights claimants under one original contractor have to the statutory retainage being withheld from the other original contractors. The definition of "contract price" makes it clear that the owner's obligation to retain statutory retainage applies to each original contract. See TEX. PROP. CODE (1). Therefore, a separate retainage fund is required for each original contract. In Page v. Structural Wood Components, Inc., the Texas Supreme Court re-affirmed the separate retainage fund requirement. 102 S.W.3d at 720, (Tex. 2003). The Court held that the time for perfecting a lien against statutory retainage ran from the date that the original contract under which the claimant was claiming its mechanic s lien was completed or terminated. In Page, the claimant was a subcontractor who filed its mechanic s lien affidavit thirty-one (31) days after the original contract under which it was claiming was terminated by the owner. Id. at 721. The owner subsequently hired completion contractors who completed the work required under the original contract. Id. at 726. The Texas Supreme Court overturned the court of appeals, which had held that the time for perfecting the lien against retainage ran from the date of the completion of all the work "contemplated" under the original contract. In 2005, the Texas Legislature amended section of the Property Code by codifying the holding in Page with regard to the timing for perfecting the lien on retainage. However, the amendment to the Property Code also requires the owner to provide notice of the date of termination or abandonment to both a potential claimant who has requested in writing to be notified of any termination or abandonment and to a claimant who has sent a statutory lien notice. TEX. PROP. CODE If the owner fails to provide the required notice to the claimant or potential claimant, the early deadline for filing the lien affidavit will not apply to that claimant's claim. See Section IV.B.1 herein. This legislative change was intended to protect claimants who might not otherwise have known of the early date for compliance because they would not have known the date that the original contractor was terminated or had abandoned the project. B. PROCEDURES FOR PERFECTING LIENS 1. Notice of Claim: First Tier Subcontractors/Suppliers A prerequisite for perfecting a mechanic s lien claim is the sending of notices to the owner of the property being improved. The notices vary depending upon the type of lien sought or whether certain special conditions exist (e.g., specially fabricated materials). Notices should be sent by certified mail, return receipt requested, or by registered mail. TEX. PROP. CODE (e), (d), (d), and (e). All notices to the owner must also be sent to the original contractor by certified mail or registered mail. a. Fund Trapping Notice and Statutory Retainage Notice Notice must be sent to the owner and original contractor not later than the fifteenth (15 th ) day of the third (3 rd ) month following each month during which labor or materials were furnished (date of delivery controls not date of invoice). TEX. PROP. CODE (b)-(c), (e). To obtain a "fund trapping" lien, the statutory fund trapping warning must be included in the letter. Without the fund trapping language in the notice letter, the claimant will be limited to the statutory retainage lien. b. Contractual Retainage Notice This notice only applies when the claimant is a subcontractor and has an agreement providing for retainage. TEX. PROP. CODE This is commonly known as "contractual retainage" and is not to be confused with the 10% statutory retainage. A claimant who gives a contractual retainage notice and who provides notice to the owner of the filing of the lien affidavit under section of the Property Code is not required to give any other notice as to contractual retainage. To be effective, the contractual retainage notice must be sent to the owner not later than the earlier of: (i) the thirtieth (30 th ) day after the 8

12 date the claimant's agreement providing for retainage is completed, terminated or abandoned, or (ii) the thirtieth (30 th ) day after the date the original contract is terminated or abandoned. Id. at (b). A claimant who fails to provide the optional contractual retainage notice must provide notice to the owner of each month's retention (i.e., amounts earned but not yet due) as those funds are being retained. c. Specially Fabricated Materials Notice Generally, in order to obtain a lien on an owner's real property, a claimant must usually prove that his labor or materials were furnished to a particular piece of real property. One exception to the rule involves "specially fabricated" materials. TEX. PROP. CODE When the special fabrication notice is properly sent, the claimant can obtain a lien on the owner's real property even though the specially fabricated materials were never delivered to the project. The special fabrication notice must be sent to the owner not later than the fifteenth (15th) day of the second (2nd) month following the month in which the order was received and accepted. Id. at (b). However, once the materials are delivered to the project or the normal delivery time for the job has passed then the special fabrication notice is no longer valid, and the notice of claim (i.e., fund trapping) letter must be given to the owner. Id. at (f). 2. Notice of Claim: Second Tier Subcontractors/Suppliers A claimant who does not have a direct contractual relationship with the original contractor (i.e., a subcontractor contracting with another subcontractor) must comply with all notice and filing requirements imposed on subcontractors having a direct contractual relationship with the original contractor. In addition, the downstream subcontractor must also give a written notice to the original contractor not later than the fifteenth (15th) day of the second (2nd) month following each month in which the unpaid labor or materials were furnished. TEX. PROP. CODE , All other notices and filing requirements that apply to claims by first-tier subcontractors also apply to claims by derivative claimants. V. THE MECHANIC S LIEN AFFIDAVIT The timely filing of a mechanic's lien affidavit is a prerequisite for perfection of a lien claim. The deadline for filing the lien depends upon the type of lien sought or, in special situations, the type of notice letter sent to the owner. A. TIME FOR FILING AFFIDAVITS 1. Original Contractor Lien In order to perfect a statutory mechanic's lien, an original contractor must file an affidavit not later than the fifteenth (15th) day of the fourth (4th) month following the month in which the original contract has been materially breached or terminated, completed, finally settled, or abandoned. TEX. PROP. CODE (a). 2. Fund Trapping Lien If funds have been trapped by the statutory fund trapping notice, the claimant must file the lien affidavit not later than the fifteenth (15 th ) day of the fourth (4 th ) month following the last month in which labor was performed or material was furnished. TEX. PROP. CODE (a),

13 3. Statutory Retainage Lien If the claim is for a portion of the statutory retainage held by the owner, the claimant must file the affidavit within thirty (30) days after the earlier of (i) completion of the work, (ii) termination of the original contract, or (iii) abandonment of the work by the original contractor. TEX. PROP. CODE If a claimant has failed to send a notice letter with the fund trapping warning, the claimant is limited to this statutory retainage lien and must file the affidavit no later than thirty (30) days after completion of the work under the original contract. 4. Claim for Contractual Retainage If the claim is for contractual retainage and a timely contractual retainage notice letter was sent, the lien affidavit must be filed either: (i) not later than the thirtieth (30 th ) day after the earlier of the date (a) the work is completed; (b) the original contract is terminated; or (c) the original contractor abandons the project. TEX. PROP. CODE ; or (ii) not later than the earliest of (a) the date required for filings under section of the Property Code; (b) the fortieth (40 th ) day after the date stated in the affidavit of completion as the date of completion, if the owner sent the claimant the notice of completion in the time and manner required; (c) the fortieth (40 th ) day after the date of termination or abandonment of the original contract, if the owner sent the claimant a notice of completion in the time and manner required; or (d) the thirtieth (30 th ) day after the date the owner sent a written demand for the claimant to file a mechanic s lien affidavit to the address listed in the notice for contractual retainage. TEX. PROP. CODE (f). 5. Specially Fabricated Materials If the claim is for specially fabricated materials, and a timely special fabrication notice letter was sent, the lien affidavit must be filed by the fifteenth (15 th ) of the fourth (4 th ) month following: (i) the last month in which the materials were delivered; (ii) the last month in which the materials would normally have been required; or (iii) the month in which the contract between the owner and original contractor was breached or terminated. TEX. PROP. CODE , (d). B. CONTENTS OF LIEN AFFIDAVIT The lien affidavit must be signed by the person claiming the lien or by another person on the claimant's behalf. TEX. PROP. CODE (a). It is an affidavit and, therefore, must contain a properly executed jurat (not just an acknowledgment). Sugarland Bus. Ctr., Ltd. v. Norman, 624 S.W.2d 639 (Tex. Civ. App. Houston [14th Dist.] 1981, no writ); Taylor v. Rigby, 574 S.W.2d 833, 837 (Tex. Civ. App. Tyler 1978, writ ref'd n.r.e.). The claimant (the affiant) must swear to the truth of the information based upon personal knowledge. An affidavit that is made "to the best of affiant's knowledge and belief" is defective. Merchants' & Planters' Bank v. Hollis, 84 S.W. 269, 270 (Tex. Civ. App. 1904, no writ). Lien affidavits must contain "substantially" the following information: (a) (b) (c) A sworn statement of the amount of the claim; The name and last known address of the owner or reputed owner; A general statement of the kind of work done or materials furnished by the claimant, 10

14 (d) (e) (f) (g) The name and last known address of the person by whom the claimant was employed or to whom the claimant furnished the materials or labor; A description, legally sufficient for identification, of the property sought to be charged with the lien; The claimant's name, mailing address, and, if different, physical address; and for a claimant other than the original contractor: (i) a statement of each month in which the work was done or materials were furnished for which payment is requested; (ii) The name and last known address of the original contractor; and (iii) A statement identifying the date each notice of the claim was sent to the owner and the method by which the notice was sent. TEX. PROP. CODE (a). Claimants are permitted, but not required, to attach to the affidavit copies of the contract or the claimant's billings or other documentation in support of the claim or to attach copies of the notices sent to the owner. Id. at (b). Claimants need only "substantially comply" with the lien affidavit requirements (i.e., claimants may not "materially depart" from the statutory requirements). Texcalco, Inc. v. McMillan, 524 S.W.2d 405, 407 (Tex. Civ. App. Eastland 1975, no writ); Mustang Tractor & Equip. Co. v. Hartford Accident & Indem. Co., 263 S.W.3d 437 (Tex. App. Austin 2008, pet. denied). In holding that the failure to include a mailing address for the claimant within the body of the affidavit did not render the affidavit fatally defective, the court in Richardson v. Mid-Cities Drywall, Inc. stated that "substantial compliance is shown to exist where no one has been misled to his prejudice." 968 S.W.2d 512, 515 (Tex. App. Texarkana 1998, no pet.). However, strict compliance with the notice deadlines is required. Wiseman Hardware Co. v. R. L King Constr. Co., 387 S.W.2d 79 (Tex. Civ. App. Dallas 1965, no writ); Wesco Dist., Inc. v. Westport Grp., Inc., 150 S.W.3d 553 (Tex. App. Austin 2004, no pet.); Morrell Masonry Supply, Inc. v. Loeb, 349 S.W.3d 664 (Tex. App. Houston [14th Dist.] 2011, no pet.); Morrell Masonry Supply, Inc. v. Lupe s Shenandoah Reserve, LLC, 363 S.W.3d 901 (Tex. App. Beaumont 2012, no pet.) (holding that failing to timely send the required second month notice to the general contractor resulted in an invalid lien as to the amount that was not properly noticed). 6 C. NOTICE OF FILED AFFIDAVIT Within five (5) days of filing the affidavit with the county clerk of the county in which the project is located, the claimant must send a copy of the affidavit by registered or certified mail to the owner. TEX. PROP. CODE For a claimant other than the original contractor, a copy of the mechanic s lien affidavit must also be sent to the original contractor's last known business or residence address. Id. VI. LIEN PRIORITY A. TO WHAT PROPERTY DOES A LIEN ATTACH The property covered by the mechanic's lien includes the building or improvements repaired or constructed and the land (the lot or lots in an urban area and up to 50 acres in a rural area) on which the 6 But see Ready Cable, Inc. v. RJP Southern Comfort Homes, Inc., 295 S.W.3d 763 (Tex. App. Austin 2009, no pet.). In Ready Cable, it was determined that the county clerk improperly refused to accept a lien filing when it was presented on the 15 th day of the month, the last day under which the lien could be filed. Therefore, the Austin Court of Appeals held where there is no legitimate basis for a clerk s refusal to file the lien affidavit then the affidavit should be deemed to have been filed on the date it was delivered for filing. Consequently, the late filing of the lien was permitted. 11

15 improvements are located. 7 TEX. PROP. CODE ; Houston Elec. Distrib. Co. v. MBB Enters., 703 S.W.2d 206 (Tex. App. Houston [14th Dist.] 1985, no writ). When improvements are located on one portion of a lot in an urban area, the entire lot is subject to the lien. See Williams v. Owen, 111 S.W.2d 1182, (Tex. Civ. App. Fort Worth 1937, no writ). There is no limit on the size of the lot the plat or survey will control. Valdez v. Diamond Shamrock Ref. & Mktg. Co., 842 S.W.2d 273, 275 (Tex. 1992). The lien extends not only to the real property but to the buildings and improvements located thereon. In other words, "fixtures" (personal property which has become "permanently annexed" to the real property and the permanent improvements thereon) are subject to the mechanic's lien. First Nat'l. Bank in Dallas v. Whirlpool Corp., 517 S.W.2d 262, 266 (Tex. 1974). Mere personal property located on the real property which has never become affixed to and a part of the real property or permanent improvements (such as furniture and free-standing, plugged-in appliances) are not subject to the mechanic's lien. Id. B. INCEPTION OF THE MECHANIC'S LIEN THE RELATION BACK DOCTRINE 1. The Relation Back Doctrine One of the most difficult issues when evaluating a mechanic's lien is trying to determine its relative interest in the property in relation to competing claims against and interests in the property. "Priority" is, of course, extremely important because under Texas law when a prior lien is foreclosed, then the foreclosure sale will usually extinguish all secondary liens. In other words, if a bank has a prior deed of trust lien on a piece of real property and forecloses that lien, the foreclosure sale will eliminate any secondary mechanic's liens on the real property. See e.g., Coke Lumber & Mfg. Co. v. First Nat'l Bank in Dallas, 529 S.W.2d 612 (Tex. Civ. App. Dallas 1975, writ ref'd). Priority is usually determined by the date the lien or property interest was "perfected." In most cases, the date the lien was filed with the county clerk is the day it was perfected. However, mechanic's liens have an "inception" date of when the first visible work on the project is commenced not when the particular mechanic's lien is perfected. TEX. PROP. CODE Therefore, even though the mechanic's lien is not filed until many months after commenced, the relative priority date for the mechanic's lien relates back to the date of the commencement of the visible work. 8 Diversified Mortg. Inv'rs v. Lloyd D. Blaylock Gen. Contractor, Inc., 576 S.W.2d 794, 803 (Tex. 1978). This is known as the "Relation Back Doctrine." According to section of the Property Code, all mechanic's liens have priority over any lien, mortgage or encumbrance recorded or arising after the date of the inception of the mechanic's lien. 2. Establishing the Commencement of Construction Pursuant to section of the Property Code, the time for the inception of a mechanic's lien (other than for an architect, engineer, surveyor, demolition contractor or landscaper) is the earlier of: (i) the commencement of visible construction of improvements on the land on which the improvements 7 The limitation to the lots on which the improvements are located and up to 50 acres in a non-urban area only applies to the lien arising under Chapter 53 of the Texas Property Code. The scope of the "constitutional lien" extends to "the land necessary" to the use and enjoyment of the building or improvements being repaired or constructed. Strang v. Pray, 35 S.W. 1054, 1055 (Tex. 1896). 8 The exception to the Relation Back Doctrine are mechanic's liens filed by architects, engineers, surveyors, landscapers and demolition contractors. By statute, the time of inception for those lien claimants is the date the lien is filed. 12

16 are to be located, (ii) the first delivery of materials to be used in the construction of the improvements to the land on which the improvements are to be located or (iii) the filing of an Affidavit of Commencement pursuant to section (c) of the Property Code. In Diversified Mortgage, the Court set forth the following factors to consider when determining if the commencement of construction on the land is sufficient to constitute the inception of the lien: (i) if the construction activity is conducted on the land itself; (ii) if the activity is visible upon the land; and (iii) if the activity constitutes either (a) an activity which is defined as an "improvement" under Texas statute or (b) the excavation for the laying of the foundation of a building or a structure. 576 S.W.2d at 802. However, the clearing of a construction site is not sufficient to constitute commencement of construction for inception purposes. See Perkins Constr. Co. v. Ten-Fifteen Corp., 545 S.W.2d 494, 499 (Tex. Civ. App. San Antonio 1976, no writ). Further, with regard to the delivery of materials, in order to constitute inception of the lien, the materials delivered to the improvement site must be materials that will be used during the construction or incorporated into the permanent structure. See Diversified Mortg. Inv'rs, 576 S.W.2d at The third way to establish the priority of a deed of trust is to file an Affidavit of Commencement when the construction of the project begins. If an Affidavit of Commencement is filed, the Affidavit will serve as prima facie evidence of the date of commencement. TEX. PROP. CODE (d). This means that the Affidavit does not definitively prove the date of commencement, and a claimant may still bring forth evidence that the work actually began earlier in time. However, in the absence of proof to the contrary, the Affidavit will establish the date of commencement in any legal proceeding where liens or property interests are at issue. The Affidavit of Commencement should be filed in the real property records of the county where the project is located no later than thirty (30) days after the date of commencement. Id. at (c). The Affidavit must contain the following information: (i) the name and address of the original contractor, (ii) the name and address of the owner, (iii) legal description of the property, (iv) a general description of the improvements being constructed, and (v) the date the work actually commenced. Id. at (c). C. REMOVABLE PROPERTY Perfected mechanic's liens are granted preference over all other liens on improvements, despite even a prior mortgage lien, if the removal of the improvement can be accomplished without material injury to the land, pre-existing improvements or to the materials removed (i.e., removables). Id. at ; Exch. Sav. & Loan Ass'n v. Monocrete, 629 S.W.2d 34, 36 (Tex. 1982); First Nat'l Bank v. Whirlpool Corp., 517 S.W.2d 262, 269 (Tex. 1974). 1. Who May Assert a Claim To Removables In the past, courts have grappled with the issue of who is entitled to claim a lien on removables. However, it is generally accepted that while the claimant does not have to prove that it furnished all of the removables, it must establish that some portion of the removables were either furnished by or through the claimant. Dorsett Bros. v. Safeco Title Ins., 880 S.W.2d 417, 423 (Tex. App. Houston [14th Dist.] 1993, writ denied). Therefore, the subcontractor furnishing the materials and the original contractor through which the subcontractor is claiming, may assert a claim to removables. See Kaspar v. Cockrell-Riggins Lighting Co., 511 S.W.2d 109 (Tex. Civ. App. Eastland 1974, no writ); L & N Consultants, Inc. v. Richard H. Sikes, Inc., 648 S.W.2d 368 (Tex. App. Dallas 1983, writ ref'd n.r.e.). Claimants who are entitled to claim a mechanic s lien on removables may not engage in "self-help" remedies with regard to 13