How often have you seen this happen? A general contractor completes construction of a residential or commercial building for someone else. At or prior to the closing for the permanent financing, the general contractor is required to provide a Final Affidavit and Waiver of Lien ("Lien Waiver") to the effect that the general contractor has paid all of its subcontractors and suppliers on the project.
The Lien Waiver is submitted, the loan closes, the lender advances funds, the title insurer issues a title insurance policy, the owner gets his home or building, the general contractor gets his money, and everyone goes home happy. However, less than 120 days later, a subcontractor or supplier files a lien against the property as a result of nonpayment by the general contractor.
What Happened?
Attorneys knowledgeable in North Carolina lien law would correctly suggest that when the general contractor issued the Lien Waiver to the Owner, he extinguished the subcontractor's subrogated lien rights with regard to a lien against the real property as provided in Chapter 44A of the North Carolina General Statutes. A knowledgeable lien lawyer would also correctly suggest that since the general contractor received full payment from the owner at the closing, the subcontractor's lien on funds provided under Chapter 44A is unavailable since there is no money owed from the owner to the general contractor.
But, what if the general contractor was the owner and general contractor during construction which is usually the case in so called "spec" homes and buildings? Under this factual variation, the subcontractor is actually a prime contractor as it had a contract directly with the owner/general contractor and, therefore, has the direct right to lien the real property under Chapter 44A. As such, the Lien Waiver the owner/general contractor signed at the closing has no impact on the lien rights of the sub (prime) contractor.
Where Does this Leave Us?
Given the relation back doctrine under Chapter 44A, the subcontractor's lien rights relate back to the date on which the subcontractor first supplied labor or materials to the project. Obviously, this date would be prior in time to the interest of the new owner and prior in time to the deed of trust.
As a result, the subcontractor's claim is superior to that of the lender and the new owner. Of course, that is why lenders require title insurance. As a result, it is usually the title insurer who gets it in the end by insuring against unfiled mechanics liens.
What Then is the Remedy of the Title Insurance Company?
North Carolina General Statute Chapter 44A section 24 may make it a crime to issue a false affidavit of payment of subcontractors and suppliers under these circumstances. Unfortunately, given all of the violent crime to deal with, prosecutors typically do not have much time or interest in prosecuting such a crime. There is always a civil action against the general contractor which, however, may be thinly capitalized or may be on the verge of insolvency or bankruptcy.
Civil Fraud Remedy
One remedy available under these circumstances which can carry a powerful consequence is that of a civil fraud claim against the principals of the recalcitrant general contractor. The fraud is based upon the false written representations set forth in the Lien Waiver which were made with the intent that they be relied upon by the new owner, lender and title insurance company and which were in fact reasonably relied upon by those parties.
This fraud is not only committed by the general contractor, but is also committed by the individuals who signed the Lien Waiver. Married partners are typically the officers of the small general contractor and one or both will typically sign the Lien Waiver as president and/or secretary. They are personally liable for their own torts even though their employer might also be vicariously liable.
The ability to pursue individual principals directly for fraud is significant. If the principals are married, they cannot hide behind "tenancy by the entireties" to protect their home from a judgment. Moreover, a fraud claim opens up the possibility of an unfair trade practice claim and treble damages under Chapter 75 along with liability for attorneys. fees.
Contractor Bankruptcy
Many times, small general contractors will attempt to avoid liability for their debts by filing corporate bankruptcy. The corporate bankruptcy generally does not stay a creditor's right to pursue a fraud claim directly against the individual principals.
Even if the individual principals also file bankruptcy, they are still not in the clear. A debt which arises out of fraud is a nondischargeable debt under the United States Bankruptcy Code. In order to obtain a determination of nondischargeability, the creditor must file a complaint in the principals bankruptcy case objecting to their discharge as to the fraud.
It is very disheartening for the principals of a general contractor to put their company into bankruptcy and go into individual bankruptcy only to learn that they cannot get rid of claims which arise out of the fraudulent Lien Waivers they signed.
Wrap-up
Contractors should beware of signing false Lien Waivers. It is fraud to do so. We may be seeing a renewed effort by owners, lenders and title insurance companies to hold contractors and subcontractors to the affirmative representations set forth in the Lien Waivers they sign.