Eliminating "Secret Liens" Under Chapter 44A
Chris Burti, Vice President and Senior Legal Counsel

During the 2009 Legislative session, the North Carolina Land Title Association (NCLTA) focused its legislative priorities on legislation designed to reduce the problems and losses arising from North Carolina's "secret" mechanic's lien statute in Chapter 44A of the North Carolina General Statutes without gutting its protection of the interests of contractors, their subcontractors and suppliers. Article X, Sec. 3 of the North Carolina State Constitution mandates that the General Assembly shall, by proper legislation, "provide for giving to mechanics and laborers an adequate lien on the subject-matter of their labor."  Thus, the structure of the law depends upon the Legislature's determination of what constitutes an 'adequate lien."

The law as currently enacted allows a contractor (or subcontractor in certain instances) to file a Claim of Lien on Real Property within 120 days of completion of their work. This lien, if established, is effective for priority purposes at the time of the first furnishing of the labor, services or material to the property by the contractor regardless of whether the property has been conveyed in the interim to an innocent purchaser for value. Under the current law, the lien will enjoy priority over purchasers or lenders regardless of whether a claim of lien has been filed of record prior to the transfer of the property. This priority aspect of the mechanics lien is referred to as "relation back" and results in what is often called a "secret" lien which cannot be identified by a diligent search of the public record. As such, if the property is transferred before the claim of lien is recorded, a new owner will file a claim against their title insurance policy for the lien, and in many cases the title insurer pays the claim / satisfies the lien.

It is important to note that the State Constitution does not mandate that there be no filing requirements at the time of first furnishing for the lien claimant to preserve priority, nor does it mandate relation back of the lien. Yet, all other creditors enjoy priority only from the time their lien is entered upon the public record. It is this characteristic that gives certainty to our land records. It is the lack of certainty in the land records as a result of this aspect of chapter 44A liens that is wreaking havoc in the current economy. Ironically, the absence of a filing requirement is proving costly to subcontractors who long have opposed any such requirement as burdensome. When the contractor is fully paid, the subcontractors lien rights are cut off.

At the request of NCLTA, former Senate Majority Leader Tony Rand introduced Senate Bill 803 in the Senate on March 24, 2009. The original version of Senate Bill 803 provided that a claim of lien on real property granted by Chapter 44A would not be effective against real property owned by purchasers for a valuable consideration, including trustees under deeds of trust on the real property and mortgagees under mortgages which secure indebtedness, whose interest has been registered in the office of the register of deeds of the county or counties in which the real property is located after the date of the first furnishing of labor or materials to the site of the improvement but prior in time to the filing of the claim of lien. Senate Bill 803 would also increase the penalty for providing a false lien waiver from a Class 1 misdemeanor to a Class H felony. Senate Bill 803 was referred to the Senate Judiciary I Committee.

After introduction, many construction industry groups opposed adoption of the bill. While many legislators and industry members agreed that there is a problem that needs to be addressed, there was no real consensus on the best way to address this problem with many unsure of any best way to address the issues. Several legislators and some construction-related groups suggested a notice requirement and Senate Bill 803 was revised to provide for a "notice of commencement" that would be filed with the Register of Deeds by any party claiming a Chapter 44A lien. This notice of commencement would provide notice that the party had a lien, and would ensure that their claim is dealt with before closing.

The major concern voiced by the construction industry to the proposed "notice of commencement" is the purported burden on the subcontractors and suppliers of filing a notice of commencement. In the interim, massive losses by subcontractors caused by general contractors defaulting on their obligations to subcontractors and suppliers after being fully paid has begun to win over many in the construction industry by demonstrating that that the burden of filing the notice will be outweighed by the benefit. If subcontractors and suppliers file a notice before closing, the closing attorney and title insurance company will know they have lien rights and will be sure they are taken care of at or before the closing. Although the construction industry generally preferred the notice of commencement version of Senate Bill 803 to the original bill, they still had concerns. One such concern is that the contractors would avoid using subcontractors that file the notices. However, it is likely the current difficulty in satisfying lien waiver requirements by general contractors will actually be eased for general contractors by the filing of these notices if it becomes common practice because closing attorneys and title examiners will be relying more on the record than on the waivers.

Any bill in the long session that has not been passed in either the Senate or the House of Representatives may not be considered in the following short session. As the Legislature's crossover deadline approached in 2009, the construction industry wanted to delay passage of the bill to allow time for more study.  Senator Rand agreed to a study bill. The legislature included the mechanic's lien study in the 2009 Studies Bill, House Bill 945. This study will be conducted by the Legislative Research Commission and the study bill provides that: "The LRC may study issues related to mechanic's liens on real property in North Carolina, including the State's current laws regarding mechanic's liens on real property, ways to address hidden liens to protect third-party purchasers for value and lenders in real estate transactions, and any other issues the Commission deems relevant to the study."

The process used in other jurisdictions and in New York in particular may be enlightening. New York's lien law, as suggested above, does provide protection to lien creditors, while at the same time, protecting subsequent purchasers by preserving the integrity of the land records. These subsequent purchasers and their lenders who rely upon the land records will do not run the risk of being subject to relation back of liens filed subsequent to the recording of their conveyances.

New York lien creditors have four months to file their notice of lien after completing improvements or furnishing materials to a single family residential property and they have eight months for commercial transactions. Any conveyance instrument filed subsequent to the commencement of the improvement that contains a covenant statement as simple as, "subject to the trust fund provisions of Section 13 of the Lien Law" would not be subject to an otherwise validly filed notice of lien:

The party taking title by a conveyance containing this covenant may rely upon the record in determining the status of title and those matters that affect it. They are not subject to relation back of an inchoate lien being filed following the closing having priority senior to the interest acquired. This lien covenant requires that the grantor or mortgagor must use the consideration or loan proceeds received to make payment first to lien claimants before using any of the funds received for any other purpose. The grantee has no obligation to ensure that the grantor has properly applied the proceeds received. Thus, even where a notice of lien is filed prior to the recording of a conveyance containing the lien covenant, if the instrument of conveyance was actually delivered to the grantee or mortgagee prior to the filing of the notice, the lien will not be valid against the interest of the grantee absent proof of collusion or fraud.

The text of the statute follows:
LIEN Article 2 - MECHANICS' LIENS § 13 Priority of liens.

(1) A lien for materials furnished or labor performed in the improvement of real property shall have priority over a conveyance, mortgage, judgment or other claim against such property not recorded, docketed or filed at the time of the filing of the notice of such lien, except as hereinafter in this chapter provided; over advances made upon any mortgage or other encumbrance thereon after such filing, except as hereinafter in this article provided; and over the claim of a creditor who has not furnished materials or performed labor upon such property, if such property has been assigned by the owner by a general assignment for the benefit of creditors, within thirty days before the filing of either of such notices; and also over an attachment hereafter issued or a money judgment hereafter recovered upon a claim, which, in whole or in part, was not for materials furnished, labor performed or moneys advanced for the improvement of such real property; and over any claim or lien acquired in any proceedings upon such judgment. Such liens shall also have priority over advances made upon a contract by an owner for an improvement of real property which contains an option to the contractor, his successor or assigns to purchase the property, if such advances were made after the time when the labor began or the first item of material was furnished, as stated in the notice of lien. If several buildings are demolished, erected, altered or repaired, or several pieces or parcels of real property are improved, under one contract, and there are conflicting liens thereon, each lienor shall have priority upon the particular part of the real property or upon the particular building or premises where his labor is performed or his materials are used. Persons shall have no priority on account of the time of filing their respective notices of liens, but all liens shall be on a parity except as hereinafter in section fifty-six of this chapter provided; and except that in all cases laborers for daily or weekly wages shall have preference over all other claimants under this article.

(1-a) Parties having assignments of moneys due or to become due under a contract for the improvement of real property, unless such assignments be set aside as diversions of trust assets as provided in article three-a of this chapter, shall have priority as follows:

An assignee of moneys or any part thereof, due or to become due under a contract for the improvement of real property, whose assignment is duly filed prior to the filing of a notice of lien or assignment of every other party to the action, shall have priority over those parties to the extent of moneys advanced upon such assignment before the filing of the notice of lien or assignment next subsequent to his assignment, but as to moneys advanced subsequent to a notice of lien or assignment filed and unsatisfied or not discharged such assignee for the purpose of determining his proportionate share of moneys available for distribution as provided in subdivision one of this section shall be treated as a lienor having a lien to the extent of moneys so advanced.

An assignee of moneys or any part thereof, due or to become due under a contract for an improvement of real property whose assignment is duly filed subsequent to the filing of the notice of lien or assignment of any other party shall for the purpose of determining his proportionate share of moneys available for distribution, as provided in subdivision one of this section be treated as a lienor having a lien to the extent of moneys actually advanced upon such assignment prior to the filing thereof.

(2) When a building loan mortgage is delivered and recorded a lien shall have priority over advances made on the building loan mortgage after the filing of the notice of lien; but such building loan mortgage, whenever recorded, to the extent of advances made before the filing of such notice of lien, shall have priority over the lien, provided it or the building loan contract contains the covenant required by subdivision three hereof, and provided the building loan contract is filed as required by section twenty-two of this chapter. Every mortgage recorded subsequent to the commencement of the improvement and before the expiration of the period specified in section ten of this chapter for filing of notice of lien after the completion of the improvement shall, to the extent of advances made before the filing of a notice of lien, have priority over liens thereafter filed if it contains the covenant required by subdivision three hereof. The lien of a vendee under an executory contract for the sale of land and the improvement thereof by the construction of a building thereon shall, to the extent of amounts paid thereunder to the vendor before the filing of a notice of lien, have priority over liens filed after the contract or memorandum thereof is recorded as provided in section two hundred ninety-four of the real property law if the recorded contract or memorandum specifies the total amount of payments made by the vendee or required by the contract to be made by the vendee before conveyance of title.

(3) Every such building loan mortgage and every mortgage recorded subsequent to the commencement of the improvement and before the expiration of the period specified in section ten of this chapter for filing of notice of lien after the completion of the improvement shall contain a covenant by the mortgagor that he will receive the advances secured thereby and will hold the right to receive such advances as a trust fund to be applied first for the purpose of paying the cost of improvement, and that he will apply the same first to the payment of the cost of improvement before using any part of the total of the same for any other purpose, provided, however, that if the party executing the building loan contract is not the owner of the fee but is the party to whom such advances are to be made, a building loan contract executed and filed pursuant to section twenty-two of this chapter shall contain the said covenant by such party executing such building loan contract, in place of the covenant by the mortgagor in the building loan mortgage as hereinbefore provided. Nothing in this subdivision shall be considered as imposing upon the lender any obligation to see to the proper application of such advances by the owner; and nothing in this section, nor in that portion of section two of this chapter, defining "cost of improvement" shall be deemed to impair or subordinate the lien of any mortgage containing the covenant required by this subdivision. To the extent that the trust res consists of the right to receive advances as distinct from advances actually received, breach of the trust shall give rise to a civil action only. The covenant provided for herein shall be deemed to have been made and to be in full force and effect if, in lieu of the foregoing provisions, a statement in substantially the following form is contained in the mortgage or contract, "subject to the trust fund provisions of section thirteen of the lien law."

(4) Nothing in subdivision two or three of this section shall apply to any mortgage given by a purchaser for value from an owner making the improvement and recorded prior to the filing of a lien pursuant to this chapter, provided the instrument of conveyance contains the provisions mentioned in subdivision five herein.

(5) No instrument of conveyance recorded subsequent to the commencement of the improvement, and before the expiration of the period specified in section ten of this chapter for filing of notice of lien after the completion of the improvement, shall be valid as against liens filed within a corresponding period of time measured from the recording of such conveyance, unless the instrument contains a covenant by the grantor that he will receive the consideration for such conveyance and will hold the right to receive such consideration as a trust fund to be applied first for the purpose of paying the cost of the improvement and that he will apply the same first to the payment of the cost of the improvement before using any part of the total of the same for any other purpose. Nothing in this subdivision shall be construed as imposing upon the grantee any obligation to see to the proper application of such consideration by the grantor. Nothing in this subdivision shall apply to a deed given by a referee or other person appointed by the court for the sole purpose of selling real property. Nothing in this subdivision shall apply to the consideration received by a grantor who, pursuant to a written agreement entered into and duly recorded prior to the commencement of the improvement, conveys to the person making such improvement, the land upon which such improvement is made. However, such a conveyance shall be subject to liens filed prior thereto, as provided by this chapter. To the extent that the trust res consists of the right to receive the consideration for such conveyance as distinct from the consideration actually received, breach of the trust shall give rise to a civil action only. The covenant provided for herein shall be deemed to have been made and to be in full force and effect if, in lieu of the foregoing provisions, a statement in substantially the following form is contained in the instrument of conveyance, "subject to the trust fund provisions of section thirteen of the lien law."

Except that this section shall not apply to any mortgage taken by the home owners' loan corporation, a corporation created under an act of congress, known as the "home owners' loan act of nineteen hundred thirty-three," and the "home owners' loan act of nineteen hundred thirty-three as amended," and said mortgage shall have priority over any and all liens filed subsequent to the date of the recording of said mortgage whether or not the cash and/or bonds for which said mortgage has been taken as security, shall have been advanced at the time of the execution of such mortgage or subsequent thereto, and it shall not be necessary to execute and file any building loan contract or any other contract, in compliance with this section or any part thereof.

(6) Every assignment of moneys, or any part thereof, due or to become due under a contract for the improvement of real property shall contain a covenant by the assignor that he will receive any moneys advanced thereunder by the assignee and will hold the right to receive such moneys as trust funds to be first applied to the payment of trust claims as defined in section seventy-one of the lien law, and that he will apply the same to such payments only, before using any part of the moneys for any other purpose.

Dirt Tales From the Deed Vault - Episode 33
John Dillard, Vice President and Legal Counsel

This month's installment of Dirt Tales again deals with the topic of the new NCLTA Mechanic's Lien Forms. In last month's article we discussed the three forms and the appropriate situation to use each. This month's article deals with another aspect of the forms and that is their exclusivity and copyright status.

The new forms are copyrighted and contain a statement to the effect that they cannot be changed or amended without the written permission of the Company (read, title insurance underwriter). All too often when a lien form is sent out of state the seller's attorney will want to modify the form to conform to local practice or to remove language in order to protect their client. This is no longer permissible and if the form is modified in this manner it will not be acceptable to the title company.

The second thing I want to mention about the new forms is that they are exclusive, meaning they are the only type of lien waiver forms that title companies will now accept. Until the industry standardized forms it was common for title companies to accept custom crafted lien waivers as long as they contained the appropriate language and indemnities. Now, regardless of how they are written title insurance underwriters will not accept any custom drafted forms nor will they accept any of the old forms for the purpose of removing the mechanics lien exception from title policies. If a custom drafted form is presented or if one of the old forms is used it will be rejected and an exception as to matters of mechanics liens will be placed in the title policy. This exception may be deleted upon certification by the certifying attorney that the statutory mechanic's lien period has expired. At first blush this policy may seem harsh, but the industry has been inundated with a barrage of mechanics lien claims in recent years and standardization of the forms becomes necessary in order to reduce some of these claims.