In a continuing four-part series, LT Construction Lawyer Wally Irvin discusses the Tennessee lien law. Wally recently posted Part 1 of 4 on “Speaking the Lien Language.” Wally continues his examination of the Tennessee lien law.
Back to Basics: Tennessee Lien Law
Post 2 of 4 (Lien on What?)
Under Tennessee lien law, a lienor may assert a lien when it performs work or furnishes materials that improve real property. Naturally, the next question is “to what property does the lien attach?” Common sense indicates the lien should attach to the entirety of the owner’s property; however, Tennessee’s mechanics’ and materialmen’s lien law (the “Act”) imposes limits on the properties subject to a lien. In this post, Tennessee Construction Lawyers look at what differentiates public and private property and the effect a property’s use has on a lienor’s ability to assert and enforce a lien.
A crucial factor in determining when a lien may be asserted under the Tennessee lien law is whether the project is public or private. In general, public property is not subject to a lien for public policy reasons, regardless of whether the project is a federal, state, county or municipal project. See, e.g., Tennessee Supply Co. v. Young, 218 S.W. 225 (Tenn. 1919);Heglar v. McAdoo Contractors, Inc., 487 S.W.2d 312 (Tenn. Ct. App. 1972). Public works are deemed exempt from statutory liens for public policy reasons; but, generally, prime contractors on these projects are required to furnish a payment bond to protect remote contractors under both Tennessee and federal law. Tennessee Construction Lawyers will review payment bond claims in a separate series; however, there are a few points that bear mentioning. First, the payment bond ensures that all remote contractors are paid and, theoretically, takes the place of a mechanics’ and materialmen’s lien. Thus the payment bond provides the exclusive remedy for those who are unpaid on a public construction project. Because the prime contractor is dealing with a governmental entity, the risk of nonpayment from the owner is not present.
[N]othing is more clear than that laborers and materialmen do not have enforceable rights against the [government] for their compensation . . . . They cannot acquire a lien on public buildings . . . and as a substitute for that more customary protection, the various statutes were passed which require that a surety guarantee their payment.Matter of RAH Development Co., Inc., 184 B.R. 525 (W.D. Mich. 1995)(quoting United States v. Munsey Trust Co., 332 U.S. 234 (1947)).
Although the government is protected by sovereign immunity from suit by remote contractors, a governmental unit has a “moral” obligation to see that contract funds are used to pay persons whose labor or material went into the performance of the work. United States Fidelity & Guaranty Co. v. United States, 475 F.2d 1377 (Ct. Cl. 1973). As we will discuss in a future series, bond claims contain just as much potential for trips and pitfalls as a mechanics’ lien, despite the government’s “moral” obligation to pay.
But, even in instances where the property is not entirely public, a court may not allow a lienor to encumber the underlying real property. For instance, a court denied enforcement of a lien against a federally subsidized low rent housing development. V.L. Nicholson Co. v. Transcon Inv. and Fin. Ltd., Inc., 595 S.W.2d 474 (Tenn. 1980). In Nicholson, a developer created a not-for-profit corporation that owned real property upon which it constructed a housing development. The corporation, however, leased the property to a municipal housing authority (the “Authority”). During construction, disputes arose out of the corporation’s failure to pay for extra work, prompting the contractor to file a lien against the property. Upon final review, the Tennessee Supreme Court analyzed decisions from other states and found most states did not allow a lien on the property of state or local governments or of housing authorities. The court noted the corporation’s charter characterized the corporation as an agency and instrumentality of the Authority. Additionally, although the corporation received minimal funding in relation to the total cost of the project, the project was designated under the United States Housing Act of 1937. In addition, the corporation was not a wholly private enterprise because it existed for the purpose of providing low rent public housing. Finally, title to the property could vest in the Authority at its request after the corporation discharged its indebtedness. Based on these facts, the court found the overall character of the property was public and deserved protection against liens and encumbrances. Accordingly, it is important to determine at the contracting state whether or not the property to be improved is public or private. If the property is public, a contractor may not assert a lien.
In contrast to public property, private property is almost always subject to a lien. In our prior post, we defined a prime contractor to be a person that contracts with the owner for an improvement to real property. In general, when an owner contracts for an improvement to its property, the contractor (lienor) may assert a lien for any unpaid balance. But, the fee owner is not the only person entitled to contract for improvements. Tennessee lien law defines an owner to include anyone who has a possessory or ownership interest in real property. Thus, an owner may include the fee owner and a lessee, among others.
A lessee is generally entitled to improve the leasehold estate. When a contractor furnishes labor or materials in furtherance of an improvement to a leasehold estate, it is entitled to assert a lien for any unpaid contract sums. The lien typically only attaches to the lessee’s interest, the leasehold estate, and does not affect the title of the record owner. However, in certain situations, the owner may require the lessee to make improvements to the property. In such a case, the lien also attaches to the owner’s interest in the property. If the lease does not require improvements, but only permits the lessee to make improvements or does not specifically address the issue, the lien may not attach to the owner’s interest.
Notwithstanding the foregoing, a lienor may not encumber a fee estate where the lienor contracts with a lessee unless the lessee is the owner’s agent. To determine if a lessee is the fee owner’s agent, courts looks to whether:
- the fee owner had the right to control the conduct of the lessee with respect to the improvement;
- the lease required the lessee to construct a specific improvement on the fee owner’s property;
- the cost of the improvement is borne by the fee owner through corresponding offsets in the amount of rent paid by the lessee;
- the fee owner maintains control over the improvement; and
- the improvement becomes the property of the fee owner at the end of the lease.
Tenn. Code Ann. §66-11-102(d). When a contractor performs work pursuant to a contract with a tenant or lessee, it is important to analyze these factors at the contracting stage to ensure adequate safeguards are in place to avoid nonpayment by the owner and to protect the contractor’s lien rights.
Residential versus non-residential real property
A lienor may assert a lien against non-residential real property; but, in some instances, residential real property may also be subject to a lien. Thus, a lienor must understand the difference between residential and non-residential property.
On most construction projects, a lienor knows whether the property is residential or non-residential property. However, the issue is more complex if the project involves multiple dwelling units or the owner does not intend to make the structure his or her principal place of residence. Property classified as residential real property for zoning purposes is not, per se, residential real property for mechanics’ and materialmen’s lien purposes. To distinguish between residential and non-residential real property, the Act sets forth elaborate definitions of “residential real property.”
“Residential real property” is defined in two ways. Determining which definition controls depends upon: 1) whether the improvement is intended for use as the owner’s primary residence; and 2) the owner’s relationship to other contracting parties.
Where the improvement is intended for use as the owner’s primary residence, residential real property is defined as:
“. . . a building consisting of one (1) dwelling unit in which the owner of the real property intends to reside or resides as the owner’s principal place of residence, including improvements to or on the parcel of property where the residential building is located, and also means a building consisting of two (2), three (3) or four (4) dwelling units where the owner of the real property intends to reside or resides in one (1) of the units as the owner’s principal place of residence, including improvements to or on the parcel of property where the residential building is located.” Tenn. Code Ann. §66-11-146(a)(1).
Most residential construction projects fall within this definition of residential real property. The statutory definition encompasses a house, duplex or small apartment complex (with no more than four units), so long as the owner resides or intends to reside in one of the units. Accordingly, large apartment complexes exceed the scope of this definition and fall within the lien provisions that govern non-residential real property. Similarly, if the improvement meets the description set forth above, but the owner does not intend to primarily reside on the property, the property is non-residential property. C&C Aluminum Builders Supply v. Rynd, 4 S.W.3d 191 (Tenn. Ct. App. 1999) (where record owner did not intend to use property as residence and subsequently conveyed property to another person, the property was not residential real property and not immune from materialmen’s lien).
However, Tennessee lien law provides an additional definition of residential real property that applies where the owner and the general contractor are the same person or entity, or where a single person or entity controls both the owner and the general contractor. In these situations, the definition of residential real property changes; and is expanded to include:
“. . . improvements to or on a parcel of property upon which a building is constructed or is to be constructed consisting of one (1) dwelling unit intended as the principal place of residence of a person or family.”
Tenn. Code Ann. §66-11-146. Although the Act defines residential real property in two ways, application of the two definitions generally produces the same result; only prime contractors may assert a lien on residential real property. Accordingly, where the owner intends for the improvement or a unit in the improvement to serve as the owner’s primary residence, a lien arises only in favor of a prime contractor. Where the owner and the prime contractor are the same person, or the same person controls both entities, a lien arises only in favor of remote contractors in privity with the prime contractor. The language of section (b) is misleading, but in application, it is similar to section (a): only those lienors who have a contract with the owner or the owner/prime contractor may claim a lien.
Privity of contract with the owner is generally a prerequisite for a party to assert a lien on residential real property. Nevertheless, suppliers repeatedly argue they are entitled to assert a lien despite a lack of privity. Suppliers frequently argue the prime contractor is the owner’s agent. For example, in W.T. Hardison & Co. v. Harding, 251 S.W.2d 829 (Tenn. Ct. App. 1952), a supplier attempted to enforce a lien on residential real property, arguing it sold material directly to the owner through the owner’s agent, the contractor. The supplier, however, billed the materials directly to the contractor. The court found a supplier must allege and prove it furnished the materials under a contract with the owner or his agent to claim a lien on residential real property. Because the supplier could not prove this essential fact, the Harding court held the supplier could not claim a lien.
Tennessee lien law only permits a contractor to assert a lien against private property. When a project is defined as residential property, Tennessee lien law further restricts the class of lienors to the first tier, requiring they have a contract with the owner. In our next post, Tennessee Construction Lawyers will review the extent to which a lien encumbers an owner’s property and the notices required to assert the lien. If you have any questions regarding the mechanics of Tennessee lien law, please feel free to contact us.