Leasehold Liens – A Coming Crisis to Subcontractors?

In North Carolina, in a tenant situation, common law limits the lien rights to the value of the leasehold, unless a connection to the landowner can be established. The NC Land Title Association (NCLTA) has proposed legislation in the current General Assembly short session to codify the common law. That, in itself, is not a bad thing. It’s the language in the changes that can cause the problem.

In effect, if you work for a tenant, you only have rights to lien the leasehold, that is the lease itself and the property of the tenant. In an ongoing business, there is value there. But, most commercial leases in NC have a clause that if the landlord cancels the lease for cause, such as non-payment of rent, all of the improvements become the property of the landlord. Some leases even contain a clause that a lien filed on the leasehold can trigger cancellation. In those cases there is no value remaining on the leasehold to collect against.

I attended a stakeholders meeting this past week at the Legislative Office Building in Raleigh. What I perceived is a lack of understanding as to the extent of leaseholds in commercial construction. The conversation would inevitably revert back to an extreme example of someone’s mother’s rental property where the tenant build a swimming pool and the contractor put a lien on his mother’s house. This is not the issue that subcontractors face. today.

When the facilitator posed the question, “How big a problem is this, really?” I spoke up and said that from the subcontractors’ point of view, this as a tremendous risk. I estimated that up to 90% of the work we do in commercial contracting involves a leasehold of some description. This can be as small as a retail tenant in a strip center to a multi-story office building being built by a developer for a single tenant. There are hidden owners like pension funds and real estate investment trusts that work through management companies. I argued for transparency up front so that the subcontractor can assess the risk before accepting the contract.

There were a couple of minor positives that came from the meeting. The study committee agreed to suggest to the legislative subcommittee that, in regards to leasehold liens, they add wording to separate commercial construction from single and two-family residential construction and to insert wording in the tenant code to make it against public policy and unenforceable for a landlord to cancel a lease because of a lien being filed.

Because a consensus of the stakeholders could not be reached, most of the NCLTA’s proposed changes were tabled until next year’s session to enable them to come up with a better way to explain the issue. I agree with the NCSA chapter attorney, Edward “Ned” McNaughton that we need to get ready and have our own legislative proposal prepared to present to next year’s session as an alternative to the NCLTA proposal.

There are even scarier things in the NCLTA’s proposed legislation, including the subcontractor’s right to a lien on real estate being subrogated (cut-off) by the general contractor’s lien waiver. As Ned has said on numerous occasions, “The title company gets paid to take risks, the subcontractor takes risks to get paid.” Much of what is contained in the proposed lien law revisions creates impediments to the subcontractors’ right to payment. It’s time for subcontractors to get involved.