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UPDATE 4/8/2014 9:45 a.m.: The Committee voted yesterday, April 7, 2014, to embrace only the second of the three recommendations discussed in my original blog post below. I have struck through the recommendations that did not survive the final draft of the report, which is now in the hands of the Legislative Research Commission for further action. Many thanks to Raleigh construction attorneys Jason Herndon and Brian Schoolman for alerting me to the Committee’s vote, as a trip out-of-state prevented my attendance at yesterday’s meeting.
The Legislative Research Committee charged with studying the lien rights of contractors and materialmen on tenant improvement projects meets a week from today, on April 7, 2014, to vote on a series of recommendations to the 2014 Session of the North Carolina General Assembly. The Committee’s recommendations can be found in its recently released draft report.
Taken together, the recommendations represent a modest but still important proposal for expanding the lien rights of prime contractors, subs & suppliers who improve “leasehold estates,” more commonly known as leased property.
The draft report recaps the Committee’s previous three meetings from earlier this year, summarizes the 2011 Pete Wall decision calling for legislative action, and then makes three primary recommendations:
1. Lien Claimants Should Have A Statutory Right to Reach the Landlord’s Property If They Can Prove the Tenant Was Acting Merely As the Agent of the Landlord. Existing common law permits lien claimants to prove that the tenant improvement was actually controlled by the landlord, and that the tenant was merely the landlord’s agent for the purposes of contracting for the improvement. Such proof allows mechanics’ lien claimants to reach the “freehold” or ownership interest of the landlord, and not just the leasehold interest of the tenant. The Committee appears poised to codify that common law in the General Statutes: The draft statute, however, does not articulate the extent to which the landlord must exert control over the improvement before its interest can be reached by a mechanics’ lien claimant. Construction industry stakeholders could not agree upon an appropriate rule, and so the Committee appears prepared to leave the standard entirely to the courts’ discretion. I would have preferred more statutory certainty on the question. By way of example, the “liens-on-leaseholds” statute passed by the Tennessee General Assembly in 2007 directs that state’s courts to consider whether the lease requires the tenant to construct a specific improvement on the landlord’s property, whether the cost of the improvement is borne by the landlord, whether the landlord maintains control over the improvement and whether the improvement becomes the property of the landlord at the end of the lease. T.C.A. § 66-11-102(d). I suspect the North Carolina General Assembly might revisit the issue of establishing a specific statutory standard during a future legislative session.
2. Payment Bonds Should Be Required On Certain “Public Property Tenant Improvements.” The Committee appears prepared to recommend that payment bonds be required on tenant improvements when the landlord is the State of North Carolina or one of its political subdivisions and the value of the tenant improvement is greater than $300,000 (or $500,000, in the case of property owned by a state agency or a member of the UNC system):
While a step in the right direction, it is critical to understand the limitations of this recommendation. It would not provide any new lien protection for contractors of any tier when the landowner is a private, rather than public, entity. It would only protect subs and suppliers on public property tenant improvements, not prime contractors. And it would not provide subs and suppliers with any added protection on public property tenant improvements with a value less than the statutory thresholds set forth above.
The proposed legislation for this recommendation can be found here.
3. Leases Should Not Be Terminated When Liens Are Filed Against the Leasehold. It is a common practice in the commercial real estate industry to include a term in lease agreements that permit the landlord to terminate a lease when a lien is filed against the real property in question. The Committee appears poised to recommend that the General Assembly make such lease terms void as against public policy: The recommendation would ensure that at a minimum, a lien claimant could turn to the tenant’s leasehold interest as security for payment.
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I am planning to attend the Committee’s fourth and final meeting next Monday and will keep you posted on its vote on the draft report.