A lawsuit or mechanic’s lien arises from many, if not most, construction projects.  Situations arise where subcontractors or materialmen are not paid, subcontractors are kicked off projects, disputes arise with respect to quality of workmanship or materials.  Disputes that occur on the project may call into question your reputation or financial strength.  Understanding key provisions of North Carolina lien law will protect your legal rights and reduce the amount of risk you assume.

Privity of Contract

A mechanic’s lien is a lien created by statute to provide for payment of materials, supplies or services used to improve or construct non-governmental real property.  Mechanic’s liens modify the common law concept of privity of contract to accomplish this task.  Privity of contract is essentially the relationship between contracting parties. Where one person contracts with another, the two are said to be in privity of contract.  Under the common law concept of privity either of the parties may bring a lawsuit against the other if a dispute arises; however, a party has no right to bring legal action against someone with whom no privity exists.  Since suppliers and subcontractors are not in contractual privity with the owner, mechanic’s liens modify this concept to allow subcontractors and suppliers to proceed against an owner for payment of materials or services provided.

Claim of Lien on Funds and Claim of Liens on Real Property

Subcontractors and suppliers have two means to secure their debts: (1) they may claim a lien on funds which are owed to the party higher up in the construction chain; and (2) they may claim a lien on the owner’s real property by subrogation (the assumption of another’s legal right) to the contractor’s lien.  These two remedies may either co-exist or be separate and distinct from one another, depending on the specific fact situation, and different limitations govern them.

Generally, a claim of lien on funds is limited to the amount owing to the entities higher up in the construction chain.  The lien is on funds which are owed and not upon funds which might have been owed had the contract been completed.  For example, Supplier serves Owner and Contractor with a notice of claim of lien on funds for $20,000.  At the time Contractor receives this notice, Contractor owes Subcontractor $10,000.  When Owner receives the notice, Owner owes Contractor $5,000.  Supplier’s lien against Contractor is limited to $10,000 since this is the amount Contractor owes Subcontractor.  However, the Supplier may also step into the shoes of Subcontractor’s right to a lien on funds against Owner.  The Subcontractor’s lien against the owner is limited to $5,000 since this is the amount that Owner owes Contractor (the party above Subcontractor in the construction chain).  Therefore, Supplier is entitled to be subrogated to the lien on funds against Owner in the amount of $5,000.  If Owner had fully paid Contractor, Supplier would still be able to claim a lien on funds owing to Subcontractor.

North Carolina case law has interpreted the statutes regarding a claim of lien on real property to create a separate and distinct right from a claim of lien on funds.  In contrast to a claim of lien on funds, a claim of lien on real property is limited only by the amount the owner owes the contractor. A person not in privity with the owner (i.e. a supplier or subcontractor) is subrogated to the contractor’s lien   Since the contractor can only claim a lien for the amount owing to the contractor, the same limitation will apply to suppliers and subcontractors.  Therefore, if the owner has fully paid the contractor, regardless of whether the contractor owes money to the first tier subcontractor, a supplier or second tier subcontractor cannot claim a lien against the owner’s real property. Using the example in the previous paragraph, subcontractors would be limited to $5,000 for a claim of lien against the owner’s real property, since this amount is what is owed to the contractor.  If the owner did not owe the contractor any money, suppliers and subcontractors would not be able to claim a lien on the real property.

Notices of Contract and Notices of Subcontract

A Notice of Contract limits the right of subrogation to enforce the contractor’s lien against the owner’s real property.  Once a Notice of Contract is properly completed, filed, and posted within 30 days of the date the building permit is issued, a second or third tier subcontractor may be prevented from claiming a lien against the real property.  The first tier subcontractor, however, is not affected.  The Notice of Contract provides the contractor and owner protection from liens placed against the property from suppliers or subcontractors with which the owner or contractor may not be aware.  In order to achieve this protection, however, certain requirements must be met.

A contractor must post the Notice of Contract in a visible location next to the posted building permit and file the original with the Clerk of Superior Court where the real property to be improved is located.  The completed and signed Notice of Contract must be posted and filed within the thirty day period described above.  Once these requirements are met, if the second or third tier subcontractor fails to serve a completed and signed Notice of Subcontract form on the contractor by certified mail or personal service, that second or third tier subcontractor will be barred from filing a claim of lien against the owner’s real property.  Therefore, the subcontractor will be limited to a lien on funds to the extent one is available.

However, a second or third tier subcontractor may be able to claim a lien on real property if he meets the statutory requirements for the Notice of Subcontract.  After the posting and filing of the Notice of Contract, if the second or third tier subcontractor properly serves the contractor with a Notice of Subcontract, that subcontractor will be entitled to a claim of lien on real property if the contractor fails to serve the subcontractor notice of every subsequent payment made to the first tier subcontractor.  This notice must be served on each second or third tier subcontractor who served the contractor with a Notice of Subcontract.  Additionally, the contractor must serve this notice of payment by certified mail or personal service within five days of the payment to the first tier subcontractor.  If, however, the contractor does properly notify each of these second or third tier subcontractors of each payment to the first tier subcontractor, no claim of lien on real property may be filed by the second or third tier subcontractors.

Understanding the general purpose behind the Notice of Contract and Notice of Subcontract may also be helpful.  Since the contractor does not normally know about all of the second or third tier subcontractors (which frequently includes suppliers), the contractor is not able to notify each of them individually.  Instead, the contractor simply posts a Notice of Contract on the property and files the original at the courthouse.  The second or third tier subcontractor initially has to do a little research to find out if a Notice of Contract exists because if that subcontractor fails to respond with a Notice of Subcontract, that subcontractor’s rights will be prejudiced.  The Notice of Subcontract serves to let the contractor know who the suppliers and subcontractors are.  Additionally, the Notice of Subcontract imposes a requirement on the contractor to notify these second or third tier subcontractors of each payment made to the first tier subcontractor after receipt of the Notice of Subcontract.  This notice of payment makes it easier for the second or third tier subcontractor to find out what funds are coming down the construction chain so the second or third tier subcontractor will be adequately protected by a claim of lien on funds.  Limiting the second or third tier subcontractors to a claim of lien on funds provides the contractor with an incentive to promptly notify these subcontractors of every payment to the first tier subcontractor.  If the contractor fails to properly notify these subcontractors, a claim of lien on real property will be available as long as the contractor is still owed money on the project.  A first tier subcontractor is not affected by these provisions and will therefore be entitled to a lien on the real property as long as funds are owing to the contractor.

How to Attack a Notice of Contract or Notice of Subcontract

A Notice of Contract may be attacked in several ways.  First, a Notice of Contract must be properly completed and signed.  If the name and address of the owner of the real property is incorrect, the Notice of Contract will most likely be invalid.  Additionally, a reasonable description of the real property must be provided, a street address, reference to a recorded deed, and other descriptions that reasonably describe the property will be sufficient.  Second, the Notice of Contract must be filed at the Clerk of Court’s office within 30 days of the date the building permit was issued.  If the contractor fails to file in time, the second or third tier subcontractors will not be limited to a claim of lien on funds.  Third, the Notice of Contract must be visibly posted next to the building permit.  Some contractors may keep the Notice of Contract in their trailer on the project; obviously, this location is insufficient.  The location must be visible so that suppliers and other remote subcontractors are aware that their right to claim a lien against the real property will be barred if they fail to respond properly with a Notice of Subcontract.

Assuming all of these requirements have been met, the contractor must still properly serve notice of each subsequent payment to the first tier subcontractor.  This notice must be sent to each second or third tier subcontractor that responded with a Notice of Subcontract.  Furthermore, each notice must be sent to the second or third tier subcontractor by certified mail or personal service within five days of each payment.  Keeping full and complete records is therefore necessary.

A Notice of Subcontract is not filed at the Clerk of Court’s office, nor is a time for service of the Notice of Subcontract imposed by statute.  A Notice of Subcontract may be served on the contractor weeks or even months after a Notice of Contract has been filed and posted.  However, the lien on funds only attaches to funds paid to the first tier subcontractor after the contractor’s receipt of the Notice of Subcontract.  Generally, a Notice of Subcontract may only be attacked if it lacks a signature, is incorrectly completed or if it is not served on the contractor by certified mail or personal service.

Conclusion

A second or third tier subcontractor should determine whether a Notice of Contract has been filed in the Clerk’s Office or posted on the project so as to preserve lien rights on the real property.  The Notice of Contract must be posted in a visible location and next to the building permit.  If you are researching whether a Notice of Contract has been filed with the Clerk’s Office, you should go to the civil division and look under the contractor’s name.

The Notice of Contract is an important tool to the contractor and the owner in protecting themselves from liens on real property.  A lien on the real property may delay or prevent the sale or transfer of the property and may also result in a forced sale of the property.  However, Notices of Contract have so far been used by typically the largest and most experienced contractors, and usually only on commercial projects.

Having a basic working knowledge of lien law is imperative to preserving important legal rights. Although mechanic’s liens are important tools with which to procure payment, the statutes are technical and must be precisely followed.  While this article is meant to be as informative as possible, every fact situation raises different legal issues.  Therefore, if you have a specific question or a recurring specific set of facts that raises legal questions, legal counsel should be consulted.