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Since construction is a credit-based business, and since contractor and material suppliers extend millions of dollars of credit each year in the form of labor and materials, Utah law allows contractors, subcontractors and material suppliers to secure their credit by placing liens on private construction projects. These liens create a risk of double payment to the owner, or loss of lien position for lenders and title companies.
The risk of double payment arises when an owner has paid the general contractor but subs or suppliers remain unpaid. These unpaid subs and suppliers can then file a lien on the property and hold the property as collateral for the amount due. This can leave the owner with the choice of either losing the home or building to lien foreclosure or paying the subs and suppliers.
Mitigating the Risk
In order to mitigate this risk, the Utah Legislature has given owners two tools: the Lien Recovery Fund and the Utah State Construction Registry.
The Lien Recovery Fund protects owners of single-family homes and duplexes from the risk of double payment by allowing them to qualify for protection. Owners qualify for protection by filing an application with the fund and showing they have a written contract with a licensed contractor, which was paid in full.
For non-residential construction projects, owners can protect themselves by using the Utah State Construction Registry. The registry laws require all potential lien claimants to file a preliminary notice in order to obtain the right to file a lien. Thus an owner can search the registry by the applicable property tax number, find the preliminary notices and make sure the contractors and suppliers who filed those notices are paid as the project progresses. Commercial property owners can also assign the liability for liens to general contractors by using an indemnity agreement.
Shoring Up Your Position
Lenders and title insurance companies are not immune from the risk of construction liens either. All liens on a construction project are treated as being filed on the date of the first preliminary notice filed in the registry. So if a preliminary notice is filed on April 1 and the construction loan closes on April 20, all of the liens of all of the contractors and suppliers working on the project will be treated as though they were filed on April 1. Thus, if the liens go into foreclosure, they will have priority over the bank’s construction loan, and in the event of a sale, the property will be sold free of the bank mortgage.
Since standard lender’s title insurance policies will usually protect against liens, lenders are well advised to have their loans insured. But for those lenders who choose to close their own loans, and for the title companies who insure the loans, there is a mechanism in the law which allows you to gain first position.
This process is called “buying first position” and it requires the lender or the title company to contact each person who filed a preliminary notice, ask them to withdraw the preliminary notice and pay them for the work performed prior to closing the loan. The deed of trust can then be recorded and the preliminary notices re-filed, the only difference being that the re-filed preliminary notices and associated lien rights now take a second position behind the loan.
The risk of double payment is real. Home and building owners, as well as lenders and title insurance companies, should use caution and consult with a legal expert to protect themselves from the risk of double payment.
Dana T. Farmer is an attorney at Smith Knowles, PC.