NY Mechanic's Lien Discharge Bond May Have Impact on Other Causes of Action

Lien Law Section 19 provides that a mechanic's lien may be discharged by the filing of a bond in the amount of 110% of the lien.  The most obvious and straight forward impact of the lien discharge bond is that, once bonded, the mechanic's lien no longer attaches to the property.  This, of course, means that in a foreclosure action the property is not being foreclosed upon but, rather, that the lienor is seeking to establish the validity of the lien so that it may recover upon the lien discharge bond.  However, as we learned recently from the Second Department's decision in Holt Construction Corp. v. Grand Palais, the lien discharge bond may impact causes of action that have nothing to do with foreclosing upon the mechanic's lien itself.

In Holt Construction the lienor plaintiff sought to set aside a conveyance of the property that the lien was originally based upon.  The lienor's argument was that a transfer of the property constituted a fraudulent conveyance of the property pursuant to Debtor and Creditor Law Section 273.  While the trial Court agreed, the Appellate Division reversed on this point noting that once the owner

 "obtained a bond to discharge the mechanic's lien, the debt no longer existed for the purposes of Debtor and Creditor Law Section 273."

The trial Court in Holt touched on another interesting, and often contested, issue: does the filing of a mechanic's lien discharge bond remove the debt from the clutches of Lien Law Article 3A?  This issue has increasingly been clarified by the Courts and the 2nd Department follows form here (following the 3rd Department) in reversing the trial court and holding that

"the discharge of a mechanic's lien by the filing of a bond is not equivalent to the payment or discharge of a trust claim pursuant to Lien Law Article 3-A. Therefore, the filing of the bond did not necessitate the dismissal of the...causes of action which were to recover damages for diversion of trust assets pursuant to Article 3-a of the Lien Law."

The lesson from Holt?  The mechanic's lien discharge bond may free up the property and make it freely transferable.  But it does not extinguish the obligations of a trustee under Lien Law Article 3-a and corporate principals may continue to be held liable for trust fund diversions even after the posting of a bond.

Vincent T. Pallaci is the managing partner of the law firm of Kushnick | Pallaci, PLLC where his practice concentrates on construction law including prosecuting and defending lien law trust fund diversion class actions.  With offices in Buffalo and Long Island, KP provides legal counsel to the construction industry across the State of New York.

Liens, bonds and arbitration clauses - oh my!

Mechanic's liens and arbitration clauses are two very common concepts in construction law.  Unfortunately, they are also two very often confusing topics that can lead to mistakes and headaches for the unprepared.  Throw in a mechanic's lien discharge bond and you have yourself a recipe for construction law disaster.  A lienor in Kings County may not have hit disaster yet, but it certainly is dealing with a massive headache and a cruel trick days before Halloween.

In PGA Mechanical Contractors v. GPNZ Realty Co. LLC the Court was faced with a request to discharge and vacate a mechanic's lien and a Lien Law Section 19 surety bond that was obtained to secure the lien.  A brief recitation of the facts indicated that the lien was filed and a foreclosure action was then timely commenced.  After the commencement of the action, but before a final judgment, the parties agreed to discontinue the mechanic's lien foreclosure action and, instead, pursue the claim in arbitration.  The mechanic's lien discharge bond was obtained after the action was commenced and before the action was discontinued in favor of arbitration.  In its decision, the Court points out that the stipulation of discontinuance is silent on the issue of whether the discharge bond must be maintained during the pendency of the action.

Much to the lienor's dismay, the Court granted the defendant's motion to discharge and cancel the surety bond and in doing so noted that a surety bond given to discharge a mechanic's lien is only obligated to satisfy a judicially established lien.  Because the action to foreclose on the mechanic's lien was discontinued, the lien could no longer be judicially established and the bond was therefore no longer necessary and could not be liable for payment of any arbitration award.

There are a few things that lienors and their attorneys can learn from this action.  First, if you have  mechanic's lien in place and you have an arbitration clause in your contract be very careful how you plot your strategy to proceed.  You want to maximize your security by keeping the lien in place for as long as possible.  Typically this situation is handled by foreclosing on the lien (if necessary) and then immediately moving to stay the action to proceed to arbitration.  There is a careful balance between protecting and preserving the lien and waiving your right to arbitrate.  Second, be very careful about the language of documents that you submit to the Court.  In this case, the lienor insisted that keeping the surety bond in place was a key component of the agreement to discontinue and arbitrate.  But the Court points out in its decision that the actual document does not say that - anywhere.  If you want a document to say something, make sure it says it!

Vincent T. Pallaci is a partner at the New York law firm of Kushnick Pallaci, PLLC.  Kushnick Pallaci is a law firm that concentrates on construction law and has offices in Long Island and Buffalo.

Who are the necessary parties to a lien foreclosure action after the mechanic's lien has been bonded?

There are typically two reasons that a mechanic's lien in New York gets bonded:  1) to remove the mechanic's lien from the property itself and remove the encumbrance from title; and 2) to prevent the owner from being sued in a foreclosure action.  A common mistake by inexperienced lienors is to name the owner in the foreclosure action as a party even though a Lien Law Section 19(4) discharge bond has already been obtained.

Lien Law Section 44-b says that once a mechanic's lien discharge bond has been obtained pursuant to Lien Law Section 19(4) (or Section 21(5) in the case of a public improvement) the owner is no longer a necessary party to the lien foreclosure action.   If the owner is named as a party, the proper procedure is to first send a notice to the attorney for the lienor demanding that the owner be immediately voluntarily removed from the action.  Refusal to remove the owner voluntarily can result in sanctions against the lienor's attorney under Rule 130-1.1 since the action against the owner is frivolous.  If the owner is not removed, a motion to dismiss or a motion for summary judgment dismissing the owner should be quickly granted.

In addition to no longer needing the owner as a necessary party, all other lienors against the real property are no longer necessary parties as they normally would have been under Lien Law Section 44.  Essentially, there are three necessary parties to the mechanic's lien foreclosure action after a bond has been obtained: the party that hired the lienor (although even this is debatable), the principal on the bond and the surety that issued the bond.  The principal on the discharge bond will be identified in the bond itself and is most easily described as the person that obtained and paid for the bond.  Often, but not always, the principal on the bond is the person that hired the lienor to provide its labor or services.

Readers of this blog likely know that I am personally of the opinion that bonding a mechanic's lien is a favor to the lienor.  The lienor then has a nice pool of money to recover from in the event that it is successful in foreclosure and the lienor then does not need to deal with all of the hassles of a foreclosure sale.  Also, because there are fewer necessary parties to the foreclosure action, the foreclosure process can be more time and cost effective.

Vincent T. Pallaci is a partner at the New York law firm of Kushnick Pallaci, PLLC where his practice focuses primarily on the area of construction law.  He can be reached at (631) 752-7100 or vtp@kushnicklaw.com

The mysterious "bond to discharge all liens"

Odds are that if you have been in the construction industry for long enough then you probably know what a payment bond is and what a performance bond is.  You probably have also come across a mechanic's lien discharge bond and perhaps even a bid bond or a maintenance bond.  But the rarely used "bond to discharge all liens" likely will leave you with a blank look on your face.  Don't worry, you wouldn't be alone.  The bond to discharge all liens is rarely used and most in the industry do not even know it exits.  But they should. 

The bond to discharge all liens is created under Lien Law Section 37.  Pursuant to Lien Law Section 37, the owner or general contractor may, either before or after work begins, obtain and file with the county clerk a bond that will prevent any lienor from attaching a mechanic's lien to the property even before that lienor does work.  The bond to discharge all liens must be in at least the amount that is unpaid under the contract between the general contractor and the owner.  In other words if you have a $5,000,000.00 contract, and you are obtaining the bond to discharge all liens  and a payment has not been made, then the bond must be in the amount of $5,000,000.00.  Likewise, if only $2,500,000.00 remains due under the contract at the time that you seek the bond to discharge all liens, then the bond must be in at least the amount of $2,500.000.00.  A caveat with the bond to discharge all liens is that a judge must set the amount of the bond to prevent owners or general contractors from being less than truthful about the amount left due under the contract in an effort to reduce the bonding costs. 

The bond must be issued by a fidelity or surety company authorized to do business within the State of New York and, in general, is the same type of surety that you would use to obtain a mechanic's lien discharge bond. 

Once the bond is obtained and filed with the clerk, the project continues the same as any other project.  However, in the event a subcontractor or supplier is not paid, rather than filing a mechanic's lien against the property, they simply go to the county clerk's office and file a claim against the lien to discharge all bonds.  The notice of claim functions in much the same way as a mechanic's lien and must be filed in the same time frame as a mechanic's lien. The notice of claim must contain:

1) the name and residence of the claimant; and if the claimant is a partnership or a corporation, the business address of such firm, or corporation, the names of partners and principal place of business, and if a foreign corporation, its principal place of business within the state;

(2) the names of the owner, contractor and surety named in the bond;

(3) the name of the person by whom the claimant was employed or to whom he furnished or is to furnish materials;

(4) the labor performed or materials furnished, including also materials actually manufactured for but not delivered to the real property, and the agreed price or value thereof;

(5) the amount unpaid to the claimant for such labor or materials;

(6) a description of the real property such as is required for a notice of lien.

You may have noticed that this is essentially the same information you would have to put into a mechanic's lien. 
 
The claim against the bond to discharge all liens is then enforced in a lawsuit much the same way that a mechanic's lien is foreclosed upon.  The summons and complaint must be filed with the county clerk where the bond is filed and must name the owner, the surety that issued the bond and all other claimants that have made claims under the bond prior to the time the action is commenced.  The bond enforcement claim must be brought within one year of the completion of the project or, if the project is abandoned, within two years of the time that the claimant last provided labor or materials to the project. 
 
Contractors should be careful.  If a bond to discharge all liens has been filed on a project you are working on, you cannot file a mechanic's lien against the property.  If you go ahead and do so anyway, the owner or the general contractor can apply to the court for summary discharge of your mechanic's lien.  This is especially important because if you file your mechanic's lien, and the owner or general contractor files a petition to discharge your lien after the time for you to file a new lien expires, then your mechanic's lien will be discharged and you will be out of time to submit a claim against the bond.  As I said at the beginning, while you many don't know what the bond to discharge all liens is, you should!
 
There are obviously pros and cons of the bond to discharge all liens.  On the pro side, it prevents liens from attaching to the property.  The lender on your construction loan will undoubtedly appreciate that.  It will also prevent the owner and the general contractor from having to continuously respond to various liens during the course of the project, especially if the lienor is far removed and the general contractor doesn't even know who the lienor is (i.e. in the case of a supplier to a sub-subcontractor).  Another pro is the scenario I described above, if a mechanic's lien is improperly filed against the property, the owner and general contractor through smart practice might be able to get the liens discharged and simultaneously prevent bond claims from being submitted.
 
The biggest con of the bond to discharge all liens is the costs.  You have to make an application to the court in the beginning of the process to set the amount of the bond.  You then have to put up the money to a surety to post the bond.  If the contract is large, this could be a substantial amount of money.  But if the surety will accept a letter of credit, the costs are minimized. 
 
The bond to discharge all liens is not for every project.  But it is a good option for the right project, maybe even yours. 
 
Vincent T. Pallaci is a partner at the New York law firm of Kushnick Pallaci, PLLC where his practice focuses primarily on the area of construction law.  KP has offices in Buffalo and Long Island allowing it to effectively provide legal counsel to the construction industry in every county in the State of New York.