NOTICE TO LENDERS: THE CONTRACTOR’S FORGOTTEN HAMMER

Date: September 10th, 2010

Faced with an owner or prime contractor who refuses or is unable to pay? Don’t know what to do other than file a lien and hope for the best? Fortunately, Washington’s mechanics’ lien statute provides contractors and suppliers with an alternative tool for securing payment: the notice to lender.

Often referred to as the ‘stop-notice statute,’ the statute allows an unpaid contractor to provide a notice commanding the lender to stop future disbursement to the owner of the outstanding, unpaid amount. After receiving the stop notice, the lender must retain sufficient funds to pay the unsatisfied debt. Where the lender fails to retain sufficient funds, the contractor’s lien becomes senior to the lender’s mortgage or deed of trust for the amount stated in the notice. This is an important characteristic of the stop-notice statute, allowing the contractor to avoid the danger of holding a junior lien on an unsatisfied debt.

Surprisingly, the statute is under-utilized by contractors and suppliers, if not altogether unknown or forgotten. Nevertheless, the stop-notice statute remains a powerful tool, securing payment for the contractor by tightening a project’s purse strings. Proper use of the stop-notice statute requires the following three steps:

STEP #1: DECIDE IF BOTH YOU AND THE PROJECT ARE ELIGIBLE FOR STOP NOTICE RELIEF.

To be eligible under the stop-notice statute, the project cannot have a payment bond that covers 50% or more of the construction financing. In practice, this restriction should only affect sub-tiered contractors and suppliers because any payment bond is typically posted by the general contractor for the benefit of subcontractors and suppliers. A general contractor who posted a payment bond would use the stop-notice statute to secure payment from the owner, while the subcontractor’s payments would be secured by the bond. Unfortunately, the stop-notice statute is not particularly well-drafted on this point, and an opposing party could argue that any qualifying payment bond prevents all parties, general contractors and subcontractors alike, from using the stop-notice statute.

In addition to the project complying with the payment bond requirement, payment must be five days or more past due. And the stop notice must be filed with the lender within 35 days of the date that payment was due under your contract. This 35 days runs from the due date in the contract, not necessarily your actual pay application or invoice date.

STEP #2: DRAFT THE NOTICE TO LENDER.

The notice to lender must: (1) state that you have furnished lienable labor, professional services, materials, supplies, or equipment; (2) describe the labor, professional services, materials, supplies, or equipment that you furnished; (3) name the prime contractor, common law agent, or construction agent that ordered the work; (4) describe the location of the real property being improved, such as providing the street address or legal description of the property; and (5) provide the name, address, and telephone number of your business. While a recent Washington appellate court decision, Williams v. Athletic Fields, Inc., gives contractors reason to be wary of forms provided under the lien statute, Washington’s legislature nevertheless provides a form for contractors and suppliers to use to notify lenders to stop lending. This form is available here.

STEP #3: DELIVER THE NOTICE TO LENDER.

You must provide the lender a written, signed stop notice with copies of the notice going to the prime contractor (if applicable) and the owner. The stop notice can be sent to the lender, owner, and prime contractor by either registered or certified mail, or by personally serving the parties with proof of service.

YOU”VE DELIVERED THE NOTICE TO LENDER… NOW WHAT?

Once the lender has received your stop notice, the lender is obligated to withhold the claimed amount from the next and subsequent disbursements to the borrower-owner. Alternatively, the owner or prime contractor can post a payment bond naming you as the beneficiary. Be aware, however, that the lender is only obligated to withhold amounts from remaining undisbursed loan funds.

The stop-notice statute only works where (1) the lender is properly notified that you have not been paid, and (2) the lender still has funds to distribute to the borrower. Accordingly, maximize the leverage provided by the stop-notice statute by keeping watch over your accounts receivables, and be willing to send a stop notice each time a payment is not received within five days after the date required by contract.

Make stop notices part of a broader plan for ensuring owner payment. For example, Section 2.2.1 of the 2007 edition of AIA’s A201 General Conditions provides contractors with one free look at the owner’s financing prior to beginning work. A simple risk management strategy might involve changing the contract term so you may request financial information during the course of the project, then using that information to determine whether a late payment warrants issuing a stop notice. If you see that the bank has been making regular disbursements to the owner but you have not been paid for your work, or if the project is nearing the final loan disbursement and you still have outstanding payments, consider getting a notice out the door as soon as possible.

Because of the dramatic effect stop notices can have, often it only takes one or two before the owner makes your payment a priority. For seriously troubled borrowers or disputes over your right to payment, you may have to ask for a court order to disburse the retained funds—but that beats having to go through a full-blown lien foreclosure action. Still, when the stakes are raised to this level, there may be no avoiding a foreclosure action or other litigation, and it is best to get construction counsel involved if they are not already.

A final note of caution: do not be tempted to use stop notices frivolously or to make clearly excessive demands for past-due payments. This can put you at risk of paying the attorneys’ fees and court costs of the owner or prime contractor challenging your stop notice. Also be sure to consider the potential unintended consequences. For instance, your stop notice may spark a rash of stop notices from other panicked contractors, potentially crimping the vital flow of cash needed to complete the project. In all cases, be circumspect and discrete. Stop notices are powerful tools, but like many powerful tools, stop notices can be dangerous when purposely misused or left in the hands of the inexperienced.