The Pitfalls of Mechanics Liens for Tenant Work
by John S. Mrowiec

Many owners, contractors and others in the construction industry assume that an unpaid debt for work on a construction project always may be secured by a mechanics lien on the real estate provided the technical notice and deadline requirements are met. Not so.

Especially in the context of contracts with tenants for improvements to leased realty, the rules can be restrictive. Statutes vary from state to state. Most states' laws impose special proof requirements on tenant improvement lien claimants who want their liens to attach to a lessor's real property.

Purdue Project

The difficulty of establishing a mechanics lien in the context of tenant improvement work under the Indiana mechanics lien statute, I.C. 33-28-3-1, is shown by the recent case of Cho d/b/a Ace Construction & Interior Design v. Purdue Research Foundation, 2004 Ind. App. LEXIS 289 (2d Dist., Feb. 26, 2004).

A tenant had leased six rooms at the Purdue Technology Center in West Lafayette, Ind. The Lease provided that Tenant was not to make alterations or improvements to the leased space without the "prior written consent" of the lessor, Purdue Research Foundation.

After entering into the lease, the tenant expressed an interest in leasing nearly 10 times more than the original space to construct a clean room to manufacture computer chips. The lessor advised the tenant that the lessor would agree to the construction of a clean room in the additional space provided the lessor and tenant reached agreement on a lease for the additional space.

While lease negotiations continued, the tenant entered into a contract with Ace Construction to design, procure equipment and construct the clean room at the Technology Center. Under the clean room engineer-procure-construct agreement, the contract would "professionally manage" the project, procure required subcontracting services and have a technical crew perform equipment installation.

The lessor did not participate in negotiating or drafting of the EPC agreement and did not sign or initial it. The tenant never provided lessor with the details or a copy of the agreement.

The contractor commenced its contract design services. The lessor advised tenant that tenant could not commence actual construction until lessor had reviewed the plans for potential impact on other tenants and a new lease was executed. The lessor also informed the contractor that construction could not commence without lessor's approval.

Eventually, the contractor requested the lessor's development director to consent to contractor's performance of ceiling tile and grid demolition and installation of metal frame in the proposed clean room space. Lessor consented to the demolition but not to the new installation.

The demolition involved removal of air conditioning ductwork, light fixtures and wiring. The contractor self-performed the demolition.

After completion of demolition, the contractor requested the lessor to review and approve the plans so that the governing authority's design approval could be obtained.
The lessor reviewed and commented on the plans. However, the lessor declined to sign approval of any construction documents because lease negotiations had not concluded.

In addition to the demolition and design work, the contractor purchased equipment and materials and placed partially completed manufacturing orders that could not be canceled at a total cost of more than $370,000. Ultimately, lessor and tenant never agreed to a lease for the clean room space.

The contractor filed a notice of mechanics lien with the county recorder. The contractor later filed suit to foreclose the lien claim. The lessor moved for summary judgment.

Suit Results

The lessor argued that there could be no lien on its property because the lessor had never actively consented to the improvements on which the lien was based. The trial court agreed with the lessor and dismissed the contractor's complaint. The contractor appealed.

On appeal, the appellate court discussed the requirements in Indiana to establish a mechanics lien on a lessor's property arising from work for a tenant. In Indiana, before a mechanics lien can attach, the landowner must consent to the improvements on which the lien is based. This consent "must be more than inactive or passive consent" and the lien claimant's burden of proof is "especially important when the improvements are requested by someone other than the landowner" Cho, 2004 Ind. App. LEXIS 289, *13 citing Stern & Son, Inc. v. Gary Joint Venture, 530 N.E.2d 306, 307 (Ind. Ct. App. 1988). Absent the owner's active consent, the lien claimant's interest attaches only to the tenant's interest.

In Cho, there was no question that the lessor "was aware of the construction" but, in Indiana, "this awareness nevertheless does not establish the sort of active consent needed to maintain a mechanics lien" Cho, 2004 Ind. App. LEXIS 289, *15. In Indiana, the active consent focus:

"is not solely on the degree of the owner's active participation in the decisions and the actual construction. Instead, the focus is also on how closely the improvement in question resemble a directly bargained-for-benefit" Cho, 2004 Ind. App. LEXIS 289, *16.

The Cho court found that the minor demolition consented to by the lessor provided no direct benefit to the lessor. Rather, the lessor spent to replace the removed ceiling when the clean room project did not proceed. Obviously, the lessor did not benefit from the design and equipment for the project never installed. Therefore, the Cho appellate court held no lien could attach to the lessor's interest.

The lesson of the Cho case for contractors is when performing tenant work, do not get too far into the process without evidence of a signed lease for the location of the planned improvements and Owner consent to the improvements. Such a contractor might not have a lien on the lessor's improvements.

Addendum

In the May 2003 column we discussed an Indiana intermediate appellate court case holding that a subcontractor was not bound to arbitrate with the prime contractor. In that case, the subcontract lacked an express arbitration clause and the incorporation by reference clause was limited to "as applicable to the work stated" in the subcontract. The Indiana Supreme Court recently affirmed the appellate court in MPACT Construction Group, LLC v. Superior Concrete Constructors, Inc., 2004 Ind. LEXIS 94 (Feb. 4, 2004).

John S. Mrowiec is a partner with Chicago-based Conway & Mrowiec, a construction and public contracts law and litigation practice. He may be reached at (312) 658-1100. For information, go to the firm's Web site at www.cmcontractors.com.