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.