Developing Strategies for Construction Payment Litigation
By Shemilly Briscoe, Esq. and Timothy J. Geswein, Esq.
Reprinted from the Clark County Bar Association’s Magazine The Communiqué Vol. 30, No 10 (October 2009)
Nevada’s licensed contractors feel the pinch of tough economic times in two fundamental ways. First, contractors find that project owners are unable or unwilling to pay for the work performed. Second, contractors have discovered that the effectiveness of their traditional enforcement mechanism—the timely recording of a mechanics lien and foreclosure—has been eviscerated by dramatic declines in real property values. As a consequence, many contractors are finding themselves in protracted and expensive litigation that results in a seemingly valueless judgment and foreclosure right.
Non-payment for work escalates
The Nevada State Contractors’ Board (Contractors’ Board) is charged with the enforcement of Chapter 624 of the Nevada Revised Statutes with the intent to promote public confidence and trust in the competence and integrity of licensees and to protect the health, safety and welfare of the public. NRS 624.005. A portion of that responsibility is to accept, categorize, and resolve complaints received from the public, project owners, and other contractors. NRS 624.355.
The Contractors’ Board defines a “money owing” complaint as a complaint arising under NRS 624.3012(2). This statute authorizes disciplinary action against a licensee for “willful or deliberate failure” to pay any money when due for any materials or services rendered in connection with the contractor’s operations when the contractor has “the capacity to pay” or when the contractor has “received sufficient money” as payment for the particular construction work. NRS 624.3012(2). The Contractors’ Board’s data reveals that “money owed” complaints have approximately doubled even though the overall number of complaints has only grown at approximately 12 percent per year.
Indeed, the Contractors’ Board, analyzing the trend in its 2007-08 Annual Report, recognized that the increase in money owing complaints “may require the reallocation of certain investigative staff” and that “formal disciplinary proceedings and summary suspension of licenses may result” from the money owing complaints. However, the Contractors’ Board cannot enforce payment provisions; the Contractors’ Board can only discipline contractors. Bivins Constr. v. State Contractors’ Bd., 107 Nev. 281, 809 P.2d 1268 (1991). Therefore, contractors may have to litigate their contracts in order to receive payment for their work.
The pinch is from both the project owner and the subcontractors
Nevada law makes the general contractor responsible for payment to subcontractors in some situations. NRS 624.624. Additionally, the Nevada Supreme Court has cast uncertainty about the enforceability of contract clauses that seek to make the subcontractor’s right to payment contingent on a general contractor’s receipt of payment. Lehrer McGovern Bovis v. Bullock Insulation, 197 P.3d 1032 (Nev. 2008). These contract terms, known as “pay-if-paid clauses,” may violate Nevada’s public policy to pay subcontractors. Id. Consequently, a general contractor who attempts to contractually limit responsibility for payment to subcontractors may find itself still responsible for payment even though unpaid by the project owner. These obligations lead to going concern issues as well as disciplinary problems for contractors. Indeed, some contractors are going out of business or reducing payroll, including the elimination of management positions. Not only does this cause the loss of skilled labor and key staff, it leaves parties who are owed money with no alternative but to litigate to recoup for their work performed. However, litigation, although necessary, has its own perils because foreclosure rights are largely affected by property values.
Foreclosure rights eviscerated by declining real property values
Nevada’s statutory system permits a contractor to lien for the unpaid balance of the price agreed upon for labor, materials, and equipment furnished. NRS 108.222. Traditionally, contractors resist recording a mechanics lien until the last opportunity because the contractor hoped to resolve the unpaid bill. This traditional approach not only reduced costs, but it also preserved the relationship with the project owner. Key in this approach is the presumption that the real property’s value exceeded the unpaid amount.
However, in today’s economy, the presumption is oftentimes false. Title reports and bankruptcy filings routinely show commercial and other “revenue generating” properties are “underwater.” In these situations, the mechanics lien on the over-encumbered property is merely another stone in the avalanche of project woes.
Unpaid contractors are then faced with the sole option of suing and seeking to foreclose on the real property. To properly exercise this option, the contractor must make timely recordings and prevail on a civil suit that seeks foreclosure as a remedy. See, generally, NRS 108.239. Alternatively, when a project owner is in bankruptcy, a contractor must timely record, file a notice known as a §546(b) notice in the bankruptcy proceeding, and pursue payment as a creditor. Under either scenario, the contractor will find that, even though the mechanics lien statutes provide for summary proceedings that include the recovery of attorney’s fees and costs, the litigation expenditures are often substantial.
Project owners, facing litigation costs to preserve an economically unviable project, are making financial decisions that would have been unthinkable just a few years ago—they are permitting contractors to pursue litigation and acquire foreclosure rights rather than satisfy the mechanics liens. In fact, many project owners are halting work and seeking bankruptcy protection. Projects that were viable when ground was broken are now semi-completed and the subject of fierce litigation, not just between the project owner and the contractor, but between the lienholders and lenders regarding priority of claims.
Conclusion and recommendations
The current economic situation requires contractors— and the attorneys who assist them—to be more prepared and on guard for project failures than ever. Attorneys assisting contractors bidding on new work should recommend strict adherence to statutory obligations that protect rights should a new project encounter financial difficulty. For those attorneys assisting contractors in situations where the existing project has encountered financial difficulties, prompt action to preserve evidence and to control the contractor’s expectations are a must. An attorney assisting a contractor on a new project would be wise to carefully explain the importance of timely recordings and filings in order to preserve statutory rights. Likewise, an attorney assisting on a new project should encourage the use of construction control accounts with fund disbursement protections to minimize the risks a general contractor takes regarding subcontractor payment. A prudent attorney would also encourage the contractor to carefully document and execute change orders. Lastly, the attorney should recommend the contractor develop a clear internal policy regarding work stoppage for non-payment that complies with Nevada law. Attorneys assisting contractors who find themselves in negotiations or litigation regarding existing projects would be wise to recommend organization of all project materials and, if necessary, the taking of sworn statements from key persons to prevent the loss of testimony as workers disperse. Additionally, the prudent attorney should obtain a current title report to confirm not only the client’s priority, but the priority position of the other lienholders. In some situations, a property appraisal may be warranted to know, at the outset of litigation, the value of the property. Bankruptcy filings should be monitored. This information will permit the attorney to make a reasoned analysis of the litigation’s prospects and to evaluate the potential value of judgment and foreclosure right. Coupled with this analysis would be a careful explanation of foreseeable litigation costs and expenses so that the contractor may make informed decisions on how to proceed. Contractors face increased risks because of today’s difficult economy. However, an attorney can assist greatly in evaluating and preserving a contractor’s ability to be paid for the work the contractor performs.