Unconditional Lien Waivers in Advance of Payment: A Dangerous Practice in Wisconsin
by John S. Mrowiec

Owners want to receive mechanics lien waivers in exchange for construction project progress and final payments. Often, contractors and subcontractors must submit the waivers along with their respective pay applications in advance of the payment. Sometimes the payment application - lien waiver - payment process is conducted by use of a title company escrow. Other times, no escrow is used.

If the owner or contractor does not pay, is a subcontractor's mechanics lien waiver tendered in advance of the requested payment still a valid waiver? The subcontractor might have waived its mechanics lien rights even without payment. The particular result depends on the relevant state law and factual circumstances.

The new case of Tri-State Mechanical, Inc. v. Northland College, 2004 Wisc. App.
LEXIS 313 (3d Dist., April 13, 2004), shows how dangerous it can be to tender a lien waiver in advance of payment in Wisconsin. In Northland College, the owner, a college, contracted with Frank Tomlinson Co., the prime contractor, to build a new science building. The prime contract was a cost plus with a guaranteed maximum price contract.

The prime contractor entered into a subcontract with Wynn O. Jones & Associates Inc. as subcontractor. The subcontractor was to install science laboratory casework materials. The subcontract was for a lump sum price. The subcontract required that the subcontractor furnish a properly executed release and waiver of liens as "an explicit condition precedent to the accrual of subcontractor's right to final payment."

The subcontractor completed its work and submitted the required final waiver.
Although the owner paid the prime contractor "the full contract price of nearly $5 million," the prime contractor never paid the subcontractor. In fact, the prime contractor went out of business.

The subcontractor timely filed its mechanics lien claim. Another subcontractor, Tri-State Mechanical, also filed a lien and initiated a suit. The subcontractor counterclaimed to foreclose its lien claim against the owner's real property and improvements and against the owner for "unjust enrichment."

Owner's Defense

The owner defended against the subcontractor's mechanics lien foreclosure, arguing the subcontractor's final lien waiver waived all mechanics lien rights. After a bench trial, the court ruled that the subcontractor could not maintain a lien claim because of the lien waiver. The court also concluded that there was no "unjust enrichment' of the owner because the owner had paid the full contract price to the prime contractor.

The subcontractor appealed. On appeal the subcontractor argued that the Wisconsin statute regarding construction liens voided the construction lien waiver provision in its subcontract and, therefore, the lien waiver the subcontractor tendered also was void.
The Northland College appellate court analyzed the Wisconsin statute. The Wisconsin statute provides:

"The following provisions in contracts for the improvement of land in this state are void:
(1) Provisions requiring a contractor, subcontractor or material supplier to waive his or her right to a construction lien or to a claim against a payment bond before he or she has been paid for the labor or materials or both that he or she furnished (Wisc. Stat. §779.135(1))."

The appellate court agreed that the Wisconsin statute voids provisions in construction contracts requiring a subcontractor to waive its right to a construction lien before payment. The Northland College court also agreed "the policy behind the statute was to ensure that contractors and subcontractors were paid for their work before they were required to produce a lien waiver" Northland College, 2004 Wisc. App. LEXIS 313, *5.

However, the Northland College court disagreed with the subcontractor's argument that the statute consequently made the subcontractor's lien waiver void. The Northland College court cited another provision of the Wisconsin statute:

"Any document signed by a lien claimant and purporting to be a waiver of construction lien rights under this subchapter, is valid and binding as a waiver whether or not consideration was paid therefore and whether the document was signed before or after the labor or material was furnished or contracted for . . . A lien claimant or potential lien claimant of whom a waiver is requested is entitled to refuse to furnish a waiver unless paid in full for the work or material to which the waiver relates (Wisc. Stat. §779.05(1))."

Reading the two sections, .135 and .05(1) together, the court instead saw the statute as providing the following:

"A subcontractor facing a void construction lien waiver provision with a choice: it can either tender a lien waiver prior to being paid or refuse to do so until it is paid. By giving the subcontractor a choice, the legislature has essentially made a policy decision that endorses whatever course of action the subcontractor takes"

Northland College, 2004 Wisc. App. LEXIS 313, 5-6. By furnishing the waiver, the Northland College court held, the subcontractor chose to accept the risk of nonpayment.

A Look at Illinois, Indiana

Citing an Illinois case, the subcontractor also argued that the lien waiver should be ineffective because the owner could not have reasonably relied on it. Without discussing any application to the facts of the case, the Northland College court rejected outright the concept as one inappropriate for judicial, rather than legislative, action. The subcontractor had effectively waived its construction lien under Wisconsin law by furnishing the unconditional final lien waiver even though the subcontractor was not paid.

The Illinois Mechanics Lien Act provides agreements to waive any right to enforce or claim a lien where the agreement is in anticipation of and in consideration for the awarding of a contract or subcontract "unenforceable" 770 ILCS 60/1.1.

An Illinois court has held that the statute made unenforceable a prime contractor's insistence on a contract provision requiring a final waiver in exchange for a payment which the subcontractor viewed as only partial payment because of disputed extras in Brown & Kerr, Inc. v. American Stores Properties, Inc., 306 Ill. App. 3d 1023, 715 N.E. 2d 804 (1st Dist. 1999). Illinois courts will enforce a final waiver of lien even without payment but recognizing the custom and practice in the industry of tendering lien waivers in advance of payment, the claimant may avoid the effect of the waiver if there was not good faith reliance on the waiver, Fisher v. Harris Bank & Trust Co., 154 Ill. App. 3d 79, 506 N.E. 2d 418 (2d Dist. 1987).

In Indiana, the statute since July 1, 2002, provides that a contract provision is void if it requires waiver of a right to lien, Ind. Code §32-38-3-16. Indiana case law prior to the Indiana legislature's adoption of the prohibition on contract provision's waiving of lien rights required consideration (usually payment) to support a waiver of lien (unlike the case law in Wisconsin and Illinois). See McCartin McAuliffe Mechanical Contractor, Inc. v. Midwest Gas Storage, Inc., 685 N.E. 2d 165, 173-74 (Ind. 1st Dist. 1997).

The issue of tendering unconditional mechanics lien waivers in advance of payment is highly technical. It certainly is not a recommended practice for potential claimants in Wisconsin.

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.