Texas Trust Fund Statute and Sham General Contractors

The Texas Trust Fund Statute makes general contractors into trustees who have a fiduciary duty to manage payments for the benefit of the subcontractors, who are the beneficiaries of the trust funds held by the general contractor. The most important thing to know about the Texas Trust Fund Statute is that it applies to anyone “who has control or direction of trust funds.” Tex. Prop. Code § 162.002. In other words, the statute dramatically expands liability beyond just the parties to the contract. Anyone who has control of the funds can be liable if the funds are misapplied. Funds are misapplied when the trustee knowingly diverts trust funds without first fully paying all obligations incurred to subcontractors. Tex. Prop. Code § 162.031(a). This means that even employees, family members, or staff of the general contractor can end up liable for the bad actions of the contractor if the employees had “control or direction” of the funds. See Direct Value, LLC v. Stock Building Supply, LLC, 388 S.W.3d 386, 392 (Tex. App.—Amarillo 2012, no pet.). However, the level of control necessary for Trust Fund Act liability to arise is more than just signatory authority over bank accounts. J.P. Morgan Chase Bank, N.A. v. Tex. Contract Carpet, Inc., 302 S.W.3d 515, 541 (Tex. App.—Austin 2009). Even a signatory to bank accounts does not have enough control to be liable under the Trust Fund Act if the person merely co-signs checks, but does not decide whether, when, how, and who will be paid; needs approval from another person to make payment decisions; and is not an officer of the company. Id. at 11-12.

The Texas Trust Fund Statute in Chapter 162 of the Texas Property Code serves as an additional source of protection, beyond the mechanic’s lien statutes, for mechanics and materialmen. It primarily benefits subcontractors. Under the Statute, construction payments are considered trust funds and the recipient is considered to be a trustee who holds the money for the beneficiaries. Tex. Prop. Code § 162.001(a). The trustee owes a fiduciary duty to the beneficiaries and must be able to show that the trustee acted towards the beneficiaries with the “utmost good faith,” the “most scrupulous honesty,” placed the beneficiaries’ interests before the fiduciary’s interest, did not use the advantage of the fiduciary’s position to gain any benefit for himself at the expense of the beneficiary, fully and fairly disclosed all important information to the beneficiary, made reasonable use of the confidence that the beneficiary placed in the fiduciary, and that the transactions in question were “fair and equitable.” Tex. Pattern Jury Charges PJC 104.2; Haut v. Green Cafe Mgmt., 376 S.W.3d 171, 182 (Tex. App.—Houston [14th Dist.] 2012). Costs and a reasonable fee that is earned under a written contract on specific property before the commencement of construction are not considered trust funds. Tex. Prop. Code § 162.001(c). Anyone who furnishes labor or material for the construction or repair of an improvement on specific real property is a beneficiary under the Trust Fund Statute. Tex. Prop. Code § 162.003. For residential construction contracts, the property owner is also a beneficiary. Id. § 162.003(b).

Exemplary Damages. Exemplary or, in other words, punitive damages can be assessed for breach of fiduciary duty. McGrede v. Coursey, 131 S.W.3d 189, 193 (Tex. App.—San Antonio 2004). The fear of potential punitive liability should serve as additional incentive to avoid violation of the Texas Trust Fund Statute. Attorney’s fees can be recoverable under Tex. Civ. Prac. & Rem. Code § 38.001(1), (2), or (3).

Private Cause of Action and Criminal Penalties. The Trust Fund Statute only provides for criminal penalties. Nevertheless, the Texas Supreme Court has “expressly indicated that a private civil cause of action exists under the Trust Fund Act.” Zurich Am. Ins. Co. v. Tejas Concrete & Materials Inc., 982 F. Supp. 2d 714, 724 (W.D. Tex. 2013); Dealers Elec. Supply Co. v. Scoggins Constr. Co., 292 S.W.3d 650 (Tex. 2009). A trustee who misapplies trust funds of over $500 commits a Class A misdemeanor, but if funds are misapplied with intent to defraud, then the violation becomes a third degree felony. Tex. Prop. Code § 162.032.

Bankruptcy. Bankruptcy is not a way to escape the Trust Fund Statute. Under Tex. Prop. Code § 162.001(d), trust funds do not become property of the bankruptcy estate.

Burden of proof. The general contractor accused of misapplication of trust funds under Tex. Prop. Code § 162.031(a) has an affirmative defense in § 162.031(b). The affirmative defense is that the “trust funds not paid to the beneficiaries of the trust were used by the trustee to pay the trustee’s actual expenses directly related” to the project. In Kirshner v. State, 997 S.W.2d 335 (Tex. App—Austin 1999, writ refused), the court held that the contractor has the burden of proof on the affirmative defense and that the beneficiaries do not have the burden of tracing the contractors’ funds to show whether the funds went toward actual expenses directly related to the project. Accordingly, the general contractor should keep detailed records that are separate for each project, so that the contractor can trace all funds expended to actual expenses of a particular project. Also, if the trustee/general contractor withholds funds due to a reasonable dispute over whether the beneficiary/subcontractor is entitled to the funds, then the trustee/general contractor must give notice to the beneficiary. Tex. Prop. Code § 162.031(b). The trustee/general contractor cannot just ignore the beneficiary/subcontractor’s request for payment.

Equitable Subrogation. A contractor or owner who pays unpaid subcontractors of subcontractors can be equitably subrogated to trust fund claims of the paid off subcontractors. The contractor or owner can then pursue whoever failed to pay the subcontractor. Tag Invs., Ltd. v. Monaco (In re Monaco), 514 B.R. 477, 485 (Bankr. W.D. Tex. 2014).

Sham Contracts:

Under Section 53.026 of the Texas Property Code, the owner of real property cannot escape liability by setting up a corporation to act as the owner’s general contractor, and thus, escape liability to subcontractors and suppliers. Specifically, the Property Code provides that if the property owner has the ability to control the person or entity that acts as a general contractor, then the subcontractor is considered to “be in a direct contractual relationship with the owner” and “has a lien as an original contractor.” Tex. Prop. Code § 53.026.

Copyright 2017, Ian Ghrist, All Rights Reserved.

Disclaimer: This blog is for informational purposes only. Do not rely on any part of this blog as legal advice. Instead, seek out the advice of a licensed attorney. Also, this information may be out-of-date.

What Landowners Need to Know About Subcontractors: Funds-Trapping, Statutory Retainage, and Other Derivative Claims

Texas law protects not only original or general contractors; who automatically obtain a lien upon the owner’s property just by providing materials or performing labor (Tex. Const. art. XVI, § 37); but also subcontractors who the owner may never meet and who may have no contracts or business dealings whatsoever with the owner. Property owners can be shocked to find that these people that they have never met can claim a lien upon the property and cloud the title, thus preventing a sale or hypothecation of the property. The original contractor holds an automatically-arising lien by the Texas Constitution, however, the Texas Constitution provides no protection to derivative claimants like subcontractors. Consequently, subcontractors’ rights come solely through compliance with the statutory mechanic’s lien laws. Generally, this means that if a subcontractor fails, in any way, to send out proper notices or file everything correctly, then the subcontractor loses its lien claim. Thus, the claims of subcontractors against the property owners can fail easily, often due to technicalities.

Derivative Claims. The subcontractors’ rights are called “derivative claims” because the rights of the subcontractors are derived from the rights of the general contractor. The general contractor is in privity of contract with the property owner (meaning that the owner and contractor have entered into a contract between the two of them) while the subcontractor is not in privity of contract with the property owner, but is in privity of contract with the general contractor. Under basic contract law, the subcontractor generally has no claim against the property owner for breach of contract when the subcontractor has not been paid because the subcontractor is only in privity with the general contractor, and so, may sue only the general contractor, and not the property owner. An exception to the general rule that only parties in privity with each other can sue for breach of contract exists when a third-party to the contract is an “intended beneficiary,” but intended-third-party-beneficiary law is complex, not specific to the State of Texas, and goes beyond the scope of this article, and the subject of mechanic’s lien and construction law, since it is a matter of general contract law principals.

A subcontractor’s lien is valid only if the correct written notice is given. If the general contractor has actual notice of a subcontractor’s claim, but does not receive timely written notice, then the subcontractor’s lien is invalid. Moore v. Brenham Ready Mix, Inc., 463 S.W.3d 109, 116 (Tex. App.—Houston [1st Dist.] 2015). Even though the mechanic’s lien statutes are “liberally construed” and “substantial compliance” with the statutes can sometimes be sufficient to perfect a lien, derivative claimants tend to have little leeway. Id. at 115, 118 (quoting First Nat’l Bank in Graham v. Sledge, 653 S.W.2d 283 (Tex. 1983). For the most part, the subcontractor who misses notices or sends them late loses its lien. Morrell Masonry Supply, Inc. v. Lupe’s Shenandoah Reserve, LLC, 363 S.W.3d 901, 904–07 (Tex. App.—Beaumont 2012, no pet.).

Statutory Retainage. Even unsophisticated Texan homeowners who pay a handyman to do some work on the house need to know about statutory retainage or else face potential derivative liability from unpaid subcontractors of the handyman. Statutory retainage is the amount of holdback funds that are required on every project. Property owners must retain ten (10) percent of the contract price of the work or ten (10) percent of the value of the work (if there is no contract price) for thirty (30) days after the work is completed. Tex. Prop. Code § 53.101. This is called the “required statutory retainage.” Special rules governing contractual retainage claims are found in Section 53.057 of the Texas Property Code. “In order to perfect a statutory retainage lien . . . a subcontractor must file its lien affidavit within thirty days of the time that the original contract is completed, terminated, or abandoned.” Tex. Prop. Code § 53.101; Page v. Marton Roofing, Inc., 102 S.W.3d 733, 734 (Tex. 2003).

Protections for Homeowners. Subchapter K of Chapter 53 of the Texas Property Code protects unsophisticated homeowners from some of the pitfalls of statutory retainage and funds-trapping law. These rules, in Sections 53.251 to 53.260 of the Texas Property Code, apply to properties “used or intended to be used as a dwelling by one of the owners.” See Tex. Prop. Code § 53.001(8)–(10). Generally, Subchapter K notice deadlines for subcontractors on residential projects are one month shorter than the non-residential deadlines. Also, the homeowner must be provided with a list of subcontractors and suppliers. See Tex. Prop. Code § 53.256. Keep in mind that even though a contractor is supposed to provide a homeowner with the disclosure from Tex. Prop. Code § 53.255 that the failure to do so does not invalidate the contractor’s lien, it only gives rise to damages against the contractor if the failure to provide the lien causes damages. Tex. Prop. Code § 53.255(c); See 1997 Texas House Bill 740, Committee Report, April 10th, 1997 (“In connection with the disclosure and disbursement statements, there are no specific remedies provided against the contractor or the lender who fails to provide these statements because the Committee believes that there are sufficient statutory causes of action available to consumers who are injured as a result of the failure to comply with a statutory disclosure requirement.”). The contractor is also required to provide funds disbursal statements, with subcontractors listed, under Tex. Prop. Code § 53.258, but again, the failure to comply does not invalidate a lien. Tex. Prop. Code § 53.258(e).

Final Bills—Paid Affidavit. Homeowners should also be aware that original contractors are required by Section 53.259 of the Texas Property Code to submit a “Final Bills—Paid Affidavit.” In this affidavit, the original contractor should either state that he has “paid each person in full for all labor and materials used” or give the names and amounts owed of anyone who remains unpaid. Additionally, the statute makes it a crime to submit a false final bills-paid affidavit and imposes personal liability on the person signing the affidavit for any incorrect information in the affidavit. Since most homeowners do not know about this law, they probably would not even think to ask for this affidavit.

Homesteads. Homesteads are different from residences. “Homesteads” are defined by Section 41.002 of the Texas Property Code, while “residences” are defined in Sections 53.001(8)–(10). Contractors working on “homesteads” need to follow the specific rules in Section 53.254 of the Texas Property Code. Contractors working on a homestead must obtain a written contract signed by both spouses to have a chance at obtaining a valid mechanic’s lien. This applies to both original and derivative claimants. Additionally, unless the property owner misrepresents the property owner’s marital status on the contract itself, even if the property owner makes misrepresentations elsewhere, a mechanic’s lien probably cannot attach without both spouses’ signatures. The Cadle Co. v. Ortiz, 227 S.W.3d 831, 838-39 (Tex. App.—Corpus Christi 2007). Accordingly, contractors should make sure to list the owner’s name in the contract as “John Doe, a single man,” or something similar, to avoid undisclosed marriages. Id. “It is well-settled that neither a constitutional lien nor a statutory mechanic’s lien may be enforced against a homestead unless a written contract for the work and material to be supplied is signed by all owners prior to the work commencing and is recorded.” Cadle v. Oritz, 227 S.W.3d at 836.; also see Tex. Const. art. XVI § 50(a)(5)(A); Tex. Prop. Code § 53.254(c). Under Tex. Prop. Code § 53.254(e), a construction contract on a homestead must be filed with the county clerk. Ultimately, because of how many rules apply to homesteads, unless the contractor is quite savvy and papered the transaction correctly, the typical homestead owner can probably escape the contractor’s claim for a mechanic’s lien.

Funds-Trapping Letters. “The statutory fund-trapping provision allows subcontractors to ‘trap, in the owner’s hands, funds payable to the general contractor if the owner receives notice from the subcontractors that they are not being paid.’ First Nat’l Bank v. Sledge, 653 S.W.2d 283, 286, 26 Tex. Sup. Ct. J. 463 (Tex. 1983). Specifically, the statute provides that an owner who receives such notice ‘may withhold from payments to the original contractor an amount necessary to pay the claim for which he receives notice.’ Tex. Prop. Code § 53.081(a). The statute further provides a remedy if the owner fails to withhold funds from the original contractor: ‘the owner is liable and the owner’s property is subject to a claim for any money paid to the original contractor after the owner was authorized to withhold funds under this subchapter.’ Id. § 53.084(b).” Page v. Marton Roofing, Inc., 102 S.W.3d 733, 734-35 (Tex. 2003). The main difference between residential and nonresidential claims is that residential claims only involve one notice, while nonresidential claims involve two sets of notices. In the nonresidential context, both notices must be sent by the deadlines for the lien to be valid. Morrell Masonry Supply, Inc. v. Lupe’s Shenandoah Reserve, LLC, 363 S.W.3d 901 (Tex. App.—Beaumont 2012, no pet.).

The following Matrix shows the funds-trapping notice rules for statutory and contractual retainage claims (known colloquially as “funds-trapping” notices). Please note that Tex. Prop. Code. § 53.058 and § 53.253 contain other rules for specially-fabricated items.

Funds-Trapping Notice Matrix

Statutory Retainage Claim

Contractual Retainage Claim

Residential

If homestead, then also comply with Tex. Prop. Code §
53.254, including giving the homeowner the statutory notice
in subsection (g).

Written notice to the owner and the original contractor of
the unpaid balance.

Deadline is the fifteenth (15th) day of the
second (2nd) month following each month in which
all or part of the claimant’s labor was performed or
material delivered.

Notice must state that “if the claim remains unpaid, the
owner may be personally liable and the owner’s property may
be subjected to a lien unless: (1) the owner withholds
payments from the contractor for payment of the claim; or
(2) the claim is otherwise paid or settled.” Tex. Prop.
Code § 53.252.

Must be sent registered or certified mail and be addressed
to the last known address for the recipient.

The notice should include “A copy of the statement or
billing in the usual and customary form.” Tex. Prop. Code §
53.252(e).

The subcontractor can either follow the rules for statutory
retainage claims, or follow the rules for contractual
retainage claims. Either are effective. Tex. Prop. Code §
53.057(a).

Notice of a contractual retainage agreement must be given
to the owner “not later than the earlier of (1) the
thirtieth (30th) day after the date the the
claimant’s agreement providing for retainage is completed,
terminated, or abandoned; or (2) the thirtieth (30 th) day after the date the original contract is
terminated or abandoned.” Tex. Prop. Code § 53.057(b).

If the contractual retainage agreement is with the original
contractor, then the notice must go to both the owner and
the original contractor by the deadline.

The notice must generally state the existence of a
requirement for retainage and contain the name and address
of the claimant and the subcontractor, if different.

The notice must be sent to the last known business or
residence address of the owner or contractor.

Tex. Prop. Code § 53.057(e) through (g) contain rules for
filing of lien affidavits in lieu of following the
statutory retainage claim rules.

Non-Residential

Subcontractor must give notice of unpaid balance to the
original contractor “not later than the fifteenth (15 th) day of the second (2nd) month
following each month in which all or part of the claimant’s
labor was performed or material delivered.” Tex. Prop. Code
§ 53.056(b).

Subcontractor must give the same notice to the owner, with a copy to the original contractor, not later than the fifteenth (15 th) day of the third (3rd) month
following each month in which all or part of the claimant’s
labor was performed or material delivered. Id.

The notice to the owner must state “if the claim remains
unpaid, the owner may be personally liable and the owner’s
property may be subjected to a lien unless: (1) the owner
withholds payments from the contractor for payment of the
claim; or (2) the claim is otherwise paid or settled.” Tex.
Prop. Code § 53.056(d).

Must be sent registered or certified mail and be addressed
to the last known business or residential address for the
recipient.

The notice should include “A copy of the statement or
billing in the usual and customary form.” Tex. Prop. Code §
53.252(e).

Copyright 2017, Ian Ghrist, All Rights Reserved.

Disclaimer: This blog is for informational purposes only. Do not rely on any part of this blog as legal advice. Instead, seek out the advice of a licensed attorney. Also, this information may be out-of-date.

How to Get Mechanic’s Liens Removed

The easiest way is to simply wait out the limitations period. Tex. Prop. Code § 53.158. If a suit is not filed by the contractor to foreclose the lien within one (1) year on a residential project or two (2) years on a commercial project, then the lien is automatically discharged of record. Id.; Tex. Prop. Code § 53.157 (listing ways that a mechanic’s lien becomes “discharged of record”). Title companies know about the “Discharge of Lien” statute and will generally insure around lien affidavits after the limitations period runs out.

Somewhat confusingly, a “lien” is defined as a “claim in property for the payment of a debt and includes a security interest.” Tex. Civ. Prac. & Rem. Code § 12.001, but mechanic’s lien affidavits on homesteads must conspicuously state that “THIS IS NOT A LIEN. THIS IS ONLY AN AFFIDAVIT CLAIMING A LIEN.” Tex. Prop. Code § 53.254. Since a “claim in property” is a lien and since the affidavit claiming a lien still clouds title to the property and prevents the homeowner from conveying the property with title insurance to a buyer, the distinction between a lien and an affidavit claiming a lien seems like a distinction without a difference. Title companies generally do not care that an affidavit claiming a lien is not actually a lien—they still will not insure the transaction without a release of the lien or claim of lien.

Title Companies:

Check with your title company regarding whether the company will “insure around” a lien. Generally, there must be some defect in the lien to do this. The title company will look at each lien claim on a case-by-case basis to evaluate whether to offer any options for insuring around the lien. You will probably need to execute an indemnity agreement with the title company and you may need to make a substantial deposit with the title company to satisfy any potential claims. Doing this can be a great alternative to a remedial bond under Tex. Prop. Code § 53.171. If the property owner insures around the lien, and then the statute of limitations runs out on the lien without the contractor filing suit, then generally, the property owner will be in the clear.

Remedial Bonds Under Section 53.171 of the Texas Property Code:

Under Section 53.171(c) of the Texas Property Code, a mechanic’s lien can be discharged with a bond even after the dispute has arisen and the lien has been filed. The bond must be substantially higher than the lien amounts. See Tex. Prop. Code § 53.172(3). The filing of the bond starts a one-year limitations period against any lien claimants. Tex. Prop. Code 53.175; Stoltz v. Honeycutt, 42 S.W.3d 305 (Tex. App.—Houston [14th Dist.] 2001, no writ). The statutory requirements for filing and notice regarding the bond should be followed to ensure that no problems arise.

Summary Motion for Lien Removal:

Section 53.160 of the Texas Property Code allows a property owner to file a “Summary Motion to Remove Invalid or Unenforceable Lien.” Tex. Prop. Code § 53.160. It is called a “summary” motion for lien removal because it allows for the lien to be removed as fast as twenty-one (21) days after the lien claimant answers or appears in the suit. Tex. Prop. Code § 53.160(c). This is obviously much faster than waiting for the Court to schedule a trial date. Getting a trial date; under the most common Discovery Control Plan—Level Two (2) (See Tex. R. Civ. P. 190.3); is going to take at least nine months, probably much longer, since the parties are entitled, in a Level Two case, to a nine-month discovery period starting with the “earlier of the date of the first oral deposition or the due date of the first response to written discovery.” Tex. R. Civ. P. 190.3(b)(1)(B)(ii). Even this “expedited” lien removal process tends to leave aggrieved property owners bitter. No one wants to file a new lawsuit, watch the process server spend a month chasing the defendants down, and then wait another month for the answer to get filed, and then wait another twenty-one days after that, to get an “expedited” hearing, especially in District Court since County Courts at Law in Texas generally do not have jurisdiction over “question[s] of title.” Escobar v. Garcia, No. 13-12-00596-CV, 2014 Tex. App. LEXIS 5157, at *9 (App.—Corpus Christi May 15, 2014, pet. denied); Tex. Gov’t Code Ann. § 26.043(8).

At the summary lien removal hearing, the lien claimant has the burden of proving that the notice of claim and affidavit of lien were furnished to the owner and original contractor (if applicable) as required. Tex. Prop. Code § 53.160(d). The movant has the burden of establishing that the lien should be removed for “any other ground authorized by this section.” Id. Despite the title of the code section, the lien cannot be removed simply because it is invalid or unenforceable. Instead, the “grounds for objecting to the validity or enforceability of the claim or lien for purposes of the motion are limited to” the seven (7) grounds listed in Texas Property Code § 53.160(b). The seven grounds are:

“(1) notice of claim was not furnished to the owner or original contractor as required by Section 53.056, 53.057, 53.058, 53.252, or 53.253;
(2) an affidavit claiming a lien failed to comply with Section 53.054 or was not filed as required by Section 53.052;
(3) notice of the filed affidavit was not furnished to the owner or original contractor as required by Section 53.055;
(4) the deadlines for perfecting a lien claim for retainage under this chapter have expired and the owner complied with the requirements of Section 53.101 and paid the retainage and all other funds owed to the original contractor before:
(A) the claimant perfected the lien claim; and
(B) the owner received a notice of the claim as required by this chapter;
(5) all funds subject to the notice of a claim to the owner and a notice regarding the retainage have been deposited in the registry of the court and the owner has no additional liability to the claimant;
(6) when the lien affidavit was filed on homestead property:
(A) no contract was executed or filed as required by Section 53.254;
(B) the affidavit claiming a lien failed to contain the notice as required by Section 53.254; or
(C) the notice of the claim failed to include the statement required by Section 53.254; and
(7) the claimant executed a valid and enforceable waiver or release of the claim or lien claimed in the affidavit.”

If the property owner’s reasons for wanting the lien removed do not neatly fit into any of these categories, then the property owner should try simply depositing “all funds subject to the notice of a claim” into the court’s registry, and getting the lien removed under Tex. Prop. Code § 53.160(5). Doing this can be cheaper than a remedial bond since the remedial bond must be substantially higher than the lien amount. See Tex. Prop. Code § 53.172(3).

One potential hiccup with the summary lien removal motion is Tex. Prop. Code § 53.161, which provides that the Court must allow the lien claimant to stay the removal of the lien by posting a bond that is a “reasonable estimate of the costs and attorney’s fees the movant is likely to incur” and that does “not exceed the amount of the lien claim.” The bond must be posted within thirty (30) days of the order. If the bond is not posted by the deadline, then the property owner can file a certified copy of the order along with a certificate from the clerk of court stating that no bond was filed within thirty (30) days after the date the order was entered by the Court and no order staying the order to remove the lien was entered by the Court. Tex. Prop. Code § 53.161(f). Upon filing the foregoing, creditors or subsequent purchasers for valuable consideration can take an interest in the property free of the lien claim. Tex. Prop. Code § 53.161(g). At this point, the property owner should have no problem selling or encumbering the property with title insurance from any title company.

If the lien claim is removed under the summary lien removal statute, but the lien claimant ultimately wins at trial, establishing the validity of the claim and getting an order for foreclosure of the lien, then the claimant can file the final judgment with the county clerk and get the lien revived. Tex. Prop. Code § 53.162.

Action on Fraudulent Lien on Property:

Property owners, real estate developers, and anyone else dealing with mechanic’s liens need to know right off the bat that the “Action on Fraudulent Lien on Property” under Tex. Gov’t Code § 51.903 is NOT a panacea for every mechanic’s lien dispute. In fact, it rarely applies. The Court dealing with this section CANNOT “make a finding as to any underlying claim of the parties involved.” Tex. Gov’t Code § 51.903(a). If a “substantive evidentiary claim” must be decided by the Court, then this procedure is unavailable. Tu Nguyen v. Bank of Am., N.A., No. 01-15-00587-CV, 2016 Tex. App. LEXIS 12595, at *7 (App.—Houston [1st Dist.] Nov. 29, 2016). For the procedure to be available, the fraudulent nature of the claim must, pretty much, be determinable by review of the document alone. Id. (citing David Powers Homes, Inc. v. M.L. Rendleman Co., 355 S.W.3d 327, 339 (Tex. App.—Houston [1st Dist.] 2011).

Section 51.903 of the Texas Government Code provides that a property owner with “reason to believe” that a previously filed “document purporting to create a lien or claim” against “real or personal property” is “fraudulent” may submit a “Motion for Judicial Review of Documentation or Instrument Purporting to Create a Lien or Claim” to the District Clerk. The motion, supporting affidavit, certificate of acknowledgement, and order on the motion should all follow the statutory formats listed in Tex. Gov’t Code § 51.903. The motion “may be ruled on by a district judge having jurisdiction over real property matters in the county where the subject document was filed.” Tex. Gov’t Code § 51.903(c). The Court’s review can be “ex parte without delay or notice of any kind.” Id. Moreover, the appellate court should “expedite review” of the trial court’s finding. Id. In filing the motion, keep in mind that documents or instruments meeting the criteria of Tex. Govt’ Code § 51.901(c) are “presumed to be fraudulent.” Tex. Gov’t Code § 51.901(c) provides that instruments are presumed fraudulent when:

“(1) the document is a purported judgment or other document purporting to memorialize or evidence an act, an order, a directive, or process of:
(A) a purported court or a purported judicial entity not expressly created or established under the constitution or the laws of this state or of the United States; or
(B) a purported judicial officer of a purported court or purported judicial entity described by Paragraph (A);
(2) the document or instrument purports to create a lien or assert a claim against real or personal property or an interest in real or personal property and:
(A) is not a document or instrument provided for by the constitution or laws of this state or of the United States;
(B) is not created by implied or express consent or agreement of the obligor, debtor, or the owner of the real or personal property or an interest in the real or personal property, if required under the laws of this state, or by implied or express consent or agreement of an agent, fiduciary, or other representative of that person; or
(C) is not an equitable, constructive, or other lien imposed by a court with jurisdiction created or established under the constitution or laws of this state or of the United States; or
(3) the document or instrument purports to create a lien or assert a claim against real or personal property or an interest in real or personal property and the document or instrument is filed by an inmate or on behalf of an inmate.”

Ordinary Certificate of Acknowledgement Instead of Short Forms for Certificates of Acknowledgement. Interestingly, a “Motion for Judicial Review of Documentation or Instrument Purporting to Create a Lien or Claim,” under Tex. Gov’t Code § 51.903(a), requires use of the “Ordinary Certificate of Acknowledgment,” (See Tex. Civ. Prac. & Rem. Code § 121.007) and not the commonly-used “Short Forms” (See Tex. Civ. Prac. & Rem. Code § 121.008).

Statutory Damages for Fraudulent Liens. If the Action on Fraudulent Lien on Property applies, then the movant should probably also file for relief under Section 12.002 of the Texas Civil Practice & Remedies Code. Under Tex. Civ. Prac. & Rem. Code § 12.002, anyone filing a claim knowing it to be fraudulent is liable to each person injured by the claim for the greater of $10,000.00 or actual damages, plus court courts, attorney’s fees, and exemplary damages. Tex. Civ. Prac. & Rem. Code § 12.002(b). With mechanic’s liens, there is no liability under this section unless the contractor “acts with intent to defraud.” Tex. Civ. Prac. & Rem. Code § 12.002(c).

Criminal Law on Fraudulent Liens. Refusal to execute a release of a fraudulent lien or claim, under Tex. Penal Code § 32.49, is a Class A misdemeanor. Also see Bowles v. State, NO. 14-99-01396-CR, 2001 Tex. App. LEXIS 6311, at *11 (App.—Houston [14th Dist.] Sep. 13, 2001). The owner, holder, or beneficiary of a purported lien or claim that is fraudulent, under Text. Gov’t Code § 51.901(c), who does not provide a release of lien by the twenty first (21st) day after the receipt of actual or written notice by certified mail or fax requesting release of the claim faces criminal liability. If that person fails to execute a release of the claim within twenty-one (21) days, then the person is “presumed to have had the intent to harm or defraud another.” Tex. Penal Code § 32.49(b). The violator could also be looking at a perjury charge depending on circumstances. Tex. Penal Code § 37.01(2)(A).

Copyright 2017, Ian Ghrist, All Rights Reserved.

Disclaimer: This blog is for informational purposes only. Do not rely on any part of this blog as legal advice. Instead, seek out the advice of a licensed attorney. Also, this information may be out-of-date.

How to Avoid Mechanic’s Liens

Usually, the lawyer gets a phone call when a problem with a mechanic’s lien has already arisen. However, there are preventative measures that property owners can take to avoid getting into mechanic’s lien situations in the first place. One method is to obtain advance or periodic mechanic’s lien waivers from your contractors. Another is to bond around any potential mechanic’s liens. Both methods require strict compliance with the relevant sections of the Texas Property Code to ensure effectiveness.

Waiver:

Residential Advance Waivers. Statutory mechanic’s liens generally cannot be waived in advance by the contractors. See Tex. Prop. Code § 53.286. However, a big exception to this rule exists for single-family homes. Under Tex. Prop. Code § 53.282(a)(3), a waiver of mechanic’s lien is enforceable if it is in a “written original contract . . . for the construction, remodel, or repair of a single-family house . . .” and is “made before labor or materials are provided under the original contract.” So, generally you can have your contractors waive their rights to file mechanic’s lien affidavits to cloud your title if it is a single-family residential project and the waiver is in the original contract signed before labor or materials or provided. Developers doing residential rehabs should consider including this waiver language in their original contracts with each of their contractors to avoid mechanic’s liens.

Statutory Progress Payment Waivers. Another waiver worth mentioning here is the statutory form waivers for progress payments. In Section 53.284 of the Texas Property Code, property developers can find a form for waiving mechanic’s liens upon the making of a progress payment. In a multi-stage development project, use of these forms contemporaneously with the payment of each draw is a best practice. Keep in mind that you cannot tell the contractor that you will not pay the contractor unless the contractor signs the waiver. You have to pay the contractor first, and then get the waiver signed. See Tex. Prop. Code § 53.283. You could tell the contractor that the contractor may not do any additional work or receive any additional payment until the contractor signs the waiver for the draws that have already been completed and paid. This way, you are waiving liens in stages as the project nears completion so that you do not get stuck with a large lien claim at the end of the project.

Fraudulent Lien Law Issues. One final note on waivers, filing a mechanic’s lien affidavit despite a valid waiver does violate the Texas Fraudulent Lien Law (Tex. Civ. Prac. & Rem. Code § 12.002), but only if the property owner sends “a written explanation of the basis for nonpayment, evidence of the contractual waiver of lien rights, and a notice of request for release of the lien to the claimant at the claimant’s address stated in the lien affidavit” and “the lien claimant does not release the lien affidavit” within fourteen (14) days. See Tex. Prop. Code § 53.282. If the reason for the lien being fraudulent does not relate to waiver, then the Fraudulent Lien Law is violated at the time that the lien claim is filed, not when the claimant refuses to release it. Vanderbilt Mortg. & Fin. v. Flores, 692 F.3d 358 (5th Cir. [Tex.] 2012).

Prompt Payment Act. It should also be noted that liability for 18% interest on unpaid amounts under the Texas Prompt Payment statute cannot be waived in a residential construction contract, but can be limited to payments not made by 60 days after the date that the owner receives the written Tex. Prop. Code. § 28.002(a) request from the contractor. Also, on residential contracts, the prompt pay good faith withholding allowed is 110%, not 100%. Tex. Prop. Code § 28.003.

Bonding Around Mechanic’s Liens:

An appropriate preventative bond will keep mechanic’s liens from arising during a project. After a dispute arises and a lien has already been filed or attempted, however, the cloud on title can still, generally, be cleared with a remedial bond.

The Texas Department of Insurance can be a good place to start looking for the right bonding company:

http://www.tdi.texas.gov/commercial/pcbond.html#type

Preventative Bonds:

Though rarely used for small residential projects, mechanic’s and materialman’s liens can be stopped with a bond that complies with Sections 53.201–53.211 of the Texas Property Code. Under § 53.201 of the Texas Property Code, “If a valid bond is filed, a claimant may not file suit against the owner or the owner’s property . . . .” “If a payment bond meets the statutory requirements, a claimant may not file lien claims against the property owner or seek foreclosure of the claimant’s lien on the owner’s property. Tex. Prop. Code § 53.201. Instead of looking to the property, claimants must look to the payment bond.” Laughlin Envtl., Inc. v. Premier Towers, L.P., 126 S.W.3d 668, 671 (Tex. App.—Houston [14th Dist.] 2004). Furthermore, “For a property owner to reap the benefits of Tex. Prop. Code § 53.211 and thereby enjoy the protections it affords, there must be a bona fide attempt to comply with the statutory requirements. Id. Under Section 53.211 of the Texas Property Code, attempted compliance with the bonding requirements of Section 53.202 of the Texas Property Code and other applicable law may be sufficient even if technical compliance is not present. Regardless, the prudent property owner or original contractor will try to strictly comply with the requirements of Section 53.202 of the Texas Property Code.

Remedial Bonds:

Remedial bonds, under Section 53.171 of the Texas Property Code, do not prevent mechanic’s liens from arising. Remedial, or indemnity, bonds can, however, clear title as to a specific lien after the claim has been filed.

Copyright 2017, Ian Ghrist, All Rights Reserved.

Disclaimer: This blog is for informational purposes only. Do not rely on any part of this blog as legal advice. Instead, seek out the advice of a licensed attorney. Also, this information may be out-of-date.

Mechanic’s Lien Law Basics

The State of Texas is a good place to be a contractor and building material supplier. The rights of these “mechanics” and “materialmen” to place liens upon real estate improved by their labor or materials arise not just from any statute, but from the Texas constitution itself. Article XVI, Section 37 of the Texas Constitution provides that “Mechanics, artisans and materialmen, of every class, shall have a lien upon the buildings and articles made or repaired by them for the value of their labor done thereon, or material furnished therefor; and the Legislature shall provide by law for the speedy and efficient enforcement of said liens.” The Texas Legislature followed its constitutional mandate with the mechanic’s lien laws in Title 5, Chapter 53 of the Texas Property Code.

Mechanic’s Liens Cloud the Property Owner’s Title, Which Can Induce the Property Owner to Pay the Contractor:

Mechanic’s lien laws are complex, can cloud title even without a lawsuit and associated lis pendens, and are quite favorable to the contractor or material supplier. Without the mechanic’s lien laws, a contractor wanting to assert rights to a mechanic’s lien would need to file a lawsuit in a Court with appropriate jurisdiction and file a lis pendens in the real property records for the county that the property is located in. This procedure is cost-prohibitive because the suit generally needs to be filed in a District Court because District Courts generally have exclusive jurisdiction over title disputes. See Escobar v. Garcia, 2014 Tex. App. LEXIS 5157, *3 (Tex. App.—Corpus Christi May 15, 2014, pet. denied). District Courts are the highest level of trial Courts in the State of Texas and tend to be the most burdensome and expensive Courts to litigate in from an attorney’s fees standpoint.

Corporations and Limited Liability Companies Must Have an Attorney in Court. To cloud title through a lis pendens, a contractor would need to hire an attorney unless the contractor has not incorporated his business. Only a contractor doing business as a sole proprietor may represent himself in District Court on a pro se basis, or in other words, without an attorney. Corporations and other legal entities may not appear in court without an attorney, even if the company is owned and operated by a single person. See Wuxi Taihu Tractor Co. v. York Grp., Inc., No. 01-13-00016-CV, 2014 Tex. App. LEXIS 12888, at *21, 2014 WL 6792019 (App.—Houston [1st Dist.] Dec. 2, 2014); Kunstoplast of Am. v. Formosa Plastics Corp., USA, 937 S.W.2d 455, 456 (Tex. 1996); Marin v. Gilberg, No. V-07-62, 2008 U.S. Dist. LEXIS 53341, at *8 (S.D. Tex. 2008).

A lis pendens is a notice of pending lawsuit that is filed publicly in the real property deed records of the county in which the property is located. The lis pendens must be indexed under the name of each party to the proceeding so that it shows up in a title search performed by an attorney or title company. The lis pendens generally has the effect of putting the world on notice of the claim and of subordinating any future unrecorded claims to the claim recorded in the lis pendens. See Tex. Prop. Code § 12.007 (2015).

Consequently, a contractor seeking to cloud title to real property, without the protections of the mechanic’s lien laws, would need to hire an attorney, file a District Court lawsuit, draft and file a proper lis pendens, and complete service of the foregoing using a private process server. For attorneys, lawsuits can be like marriages—easy to get in, hard to get out. Any attorney who makes an appearance as lead counsel under Tex. R. Civ. P. 8 must be “responsible for the suit” until such attorney withdraws from the case. Making an appearance is as simple as appearing in court on behalf of someone or filing any written document with the court. Withdrawing from the suit, on the other hand, is much more time-consuming. The attorney wanting to withdraw must follow Tex. R. Civ. P. 10, which requires the attorney to (1) show good cause, (2) submit a written motion to the court, (3) prove that the withdrawal is not sought for delay only, (4) deliver a copy of the written motion to the client, (5) notify the client in writing of the client’s right to object to the motion, (6) find out whether the client is opposed to the motion or not, (7) state the client’s last known address and (8) list all pending settings and deadlines. Moreover, the court can impose conditions before granting leave to withdraw. Finally, the notice to the client must be made by regular and certified mail.

Accordingly, most attorneys will not file a new District Court lawsuit without a substantial, up-front retainer of several thousand dollars. Even a relatively simple District Court lawsuit will cost the attorney a tremendous amount of time, energy, paperwork, and organization. Due to Tex. R. Civ. P. 8 and 10 and because getting a new attorney up to speed on the details of a case requires expenditure of substantial time and effort, finding an attorney who will file a District Court lawsuit and lis pendens for a low, flat-rate fee is highly unlikely for the aggrieved contractor.

Statutory Mecahnic’s Liens Can be Recorded Without Filing a Lawsuit:

Fortunately for contractors, Title 5, Subtitle B, Chapter 53, Subchapter C of the Texas Property Code (§§ 53.051–53.080) provides a way around the necessity of a District Court lawsuit and lis pendens. Many contractors see this as a Do-It-Yourself1 way to cloud the property owner’s title in hopes of cajoling payment from the recalcitrant property owner. Essentially, the contractor can file a mechanic’s lien affidavit in the real property deed records of the county. This affidavit will cloud the title and prevent most title companies from closing on a sale of the real property. The owner who wants to sell the property will then face a conundrum—whether to settle with the contractor or figure out a way around the lien affidavit. Often, when a property is being rehabbed, the eventual purpose of the rehab is a sale of the property with the improved rehab value. Accordingly, the lien affidavit tends to get contractors paid. The rules for how to properly perfect a mechanic’s lien using a mechanic’s lien affidavit are exceedingly complex. Accordingly, those rules are beyond the scope of this article. However, even an improper mechanic’s lien affidavit can cause enough problems at the property owner’s title company to induce the property owner to make a settlement offer to the contractor.

Work Stoppage Issues:

On the owner’s side, if the contractor is fired, then the owner should be prepared to show that the contractor was given reasonable notice. Tex. Bus. & Com. Code § 2.309. The prudent owner should set concrete deadlines or conditions and make it clear, and expressed in writing, that the failure to comply will result in termination of the contract. The prudent owner will give as much advance written notice to the contractor as possible if the owner is considering a lock-out to avoid a submission of the issue of reasonable notice to a jury.

On the contractor’s side, the contractor, if the property is not a detached residence and the contractor intends to use a work stoppage, i.e., suspension of work, due to nonpayment, then the contractor should make sure to give written notice, following the statutory requirements, to the owner and owner’s lender. See Tex. Prop. Code § 28.009. Failure to follow the rules in Tex. Prop. Code § 28.001–28.010 could result in losing the special rights granted to contractors by the Texas Prompt Payment Statute, like 18.00% interest on unpaid amounts due. The owner, upon receipt of the foregoing notices, may need to list specific reasons in writing for nonpayment to the contractor. Tex. Prop. Code § 28.009(d).

The following is a table showing the rules for contractors who are trying to perfect mechanic’s liens:

Mechanic’s Lien Rules Matrix

Original Contractor

Subcontractor

Residential

Provide the disclosure statement. Tex. Prop. Code § 53.255.

Provide the list of subcontractors and suppliers. Tex.
Prop. Code § 53.256.

For homesteads, get the contract signed by both spouses,
file it with the county clerk, and make sure to include the
notice in Tex. Prop. Code § 53.254(f) on the lien
affidavit.

File the lien affidavit by the 15th day of the
third calendar month after job completion or termination.
Tex. Prop. Code § 53.052(b).

Send copy to owner within five days. Tex. Prop. Code §
53.055.

Make sure that the original contractor complied with Tex.
Prop. Code § 53.255 & 53.256.

Give written notice by registered or certified mail of
unpaid balance to original contractor and the property
owner by 15th day of second month after “each
month in which all or part of the claimant’s labor was
performed or material . . . was delivered.” Tex. Prop. Code
§ 53.252(b), with the notice required by Tex. Prop. Code §
53.254(g) if homestead.

For homesteads, make sure to include the notice in
53.254(f) on the lien affidavit.

To trap funds, the notice must also contain the statements
in Tex. Prop. Code § 53.252(c).

File the lien affidavit by the 15th day of the
third calendar month after job completion or termination.
Tex. Prop. Code § 53.052(b).

Send copy to owner and original contractor within five
days. Tex. Prop. Code § 53.055.

Commercial

File the lien affidavit by the 15th day of the
fourth calendar month after job completion or termination.
Tex. Prop. Code § 53.052(a).

Send copy to owner within five days. Tex. Prop. Code §
53.055.

Give written notice by registered or certified mail of
unpaid balance to original contractor by 15th
day of second month after “each month in which all or part
of the claimant’s labor was performed or material
delivered.” Tex. Prop. Code § 53.056(b).

Give same notice to owner and original contractor by the 15 th day of the third month. Tex. Prop. Code §
53.056(b).

File the lien affidavit by the 15th day of the
fourth calendar month after job completion or termination.
Tex. Prop. Code § 53.052(a).

Send copy to owner and original contractor within five
days. Tex. Prop. Code § 53.055.

1Fraudulent Lien Law Warning. While many contractors in Texas try to perfect mechanic’s liens without the assistance of a licensed attorney who has studied this area of law, such Do-It-Yourself attempts should be highly discouraged. The mechanic’s lien laws are highly complex. Additionally, under Texas fraudulent lien law (Tex. Civ. Prac. & Rem. Code § 12.002; Tex. Gov’t Code § 51.901(c) and Tex. Penal Code § 32.49), the contractor can incur civil liability of the greater of $10,000.00 or actual damages (no actual damages necessary, See Harris County, Texas v. MERSCORP, Inc., 791 F.3d 545 (5th Cir. 2015); Vanderbilt Mortg. & Fin., Inc. v. Flores, 692 F.3d 358, 370, 372 (5th Cir. 2012)), plus costs and attorney’s fees, and exemplary (punitive) damages. Section 12.002(c) of the Texas Civil Practice and Remedies Code provides some protection to the uninformed lien-filing contractor by stating that “intent to defraud” is required, but “intent to defraud” can arise from claiming a larger amount than what is, in fact, owed (Taylor Elec. Servs. v. Armstrong Elec. Supply Co., 167 S.W.3d 522, 530 (Tex. App.—Fort Worth 2005, no pet.), but see RMDG Construction, LLC, et al. v. Oakwood Custom Homes Group, Ltd., 2014 Tex. App. LEXIS 6032 (Tex. App.—Waco June 5, 2014, no pet.)), refusing to release the lien, among other things (Gray v. Entis Mech. Servs., LLC, 2012 Tex. App. LEXIS 3278 (Tex. App.—Houston [1st Dist.] Apr. 26, 2012, no pet.)), or re-filing a previously released lien (Roberts v. Dixon, No. 12-15-00181-CV, 2016 Tex. App. LEXIS 2449, at *6 (App.—Tyler 2016)). Refusal to release a fraudulent lien is also a Class A misdemeanor. See Tex. Penal Code § 32.49. While courts may differ on what conduct sufficiently demonstrates “intent to defraud,” the wise and prudent contractor should consult with a competent, licensed Texas attorney in conjunction with any attempts to perfect a mechanic’s lien.

Copyright 2017, Ian Ghrist, All Rights Reserved.

Disclaimer: This blog is for informational purposes only. Do not rely on any part of this blog as legal advice. Instead, seek out the advice of a licensed attorney. Also, this information may be out-of-date.