The dangers of mechanic's liens from tenant improvements

With the economic downturn, commercial landlords have seen an increased risk of having mechanic's liens recorded against their property as a result of a tenant's (or a tenant's contractor's) failure to pay a contractor, supplier, subcontractor or laborer for improvements to the tenant's premises. Mechanic's liens can cloud title to a landlord's property, can prevent sale or refinancing, and can subject the property to risk of foreclosure by a contractor or supplier. Because the work is initiated by the tenant, these types of payment defaults are often not discovered by the landlord until after the lien has been recorded against the landlord's property. By taking a few proactive measures, a commercial landlord can reduce the risk of liens arising from a tenant's default.

Anyone supplying labor, materials or equipment in excess of $500 is protected by Nevada's mechanic's lien laws. Under Nevada law, there are essentially three steps to claiming and enforcing a mechanic's lien: Filing and serving a notice of right to lien; filing and serving a notice of lien and prosecuting a lien foreclosure action. The notice of right to lien is required where there is no direct contract with the property owner and must generally be served by certified mail to the property owner and general contractor within 31 days after the first supply of labor or materials.

Under Nevada law, regardless of whether a direct contract exists with a property owner, every improvement constructed on property is deemed to have been constructed at the direction of the owner and will subject the property to mechanic's liens for nonpayment. Nevada law generally prohibits mechanic's liens from being recorded or enforced against property of owners (referred to as "disinterested owners") that properly file and serve a notice of nonresponsibility pursuant to NRS 108.234. Where the disinterested owner is a landlord, the notice of nonresponsibility must be recorded "within three days immediately following the effective date of the lease or by the time of the execution of the lease by all parties, whichever occurs first." To be effective, the notice of nonresponsibility must identify the name and address of the disinterested owner and the person causing the work to be done, the address and legal description of the property where the improvement will be constructed, the date on which the owner first learned of the construction, and whether the disinterested owner has notified the tenant in writing that the tenant must comply with NRS 108.2403. The notice of nonresponsibility must be served on the tenant and prime contractor within 10 days of recording. If the notice of nonresponsibility meets the requirements of NRS 108.234, then the mechanics lien attaches only to the tenant's leasehold interest, not to the owner's interest in the property.

It is critical that landlords recognize that notices of nonresponsibility do not, in themselves, shield a landlord's property from mechanic's liens. In 2005, the Nevada Legislature amended Nevada lien law to provide additional protections to contractors. These changes, however, created new challenges for landlords seeking to assert nonresponsibility for work performed by tenants. These amendments generally provide that a landlord's notice of nonresponsibility is only effective if the tenant independently satisfies requirements codified in NRS 108.2403 and 108.2407. These statutes require a tenant to record a notice of posted security and either: (a) fund a construction disbursement account in an amount equal to the total cost of the tenant improvement and obtain the services of a construction control company to administer the account or (b) record a surety bond in the amount of one and a half times the tenant improvement contract. If a tenant fails to satisfy the requirements of the posted security, the prime contractor may (but is not required to) stop work. If the contractor stops work, the tenant has 25 days to meet the requirements, at which time the prime contractor must resume work. However, if the tenant fails to satisfy the requirements of the posted security, the contractor may proceed with the work and lien the landlord's property for nonpayment, notwithstanding the landlord's prior recordation of a notice of nonresponsibility.

Thus, to insure a landlord's notice of nonresponsibility has the intended effect, a landlord must also take steps to insure that the tenant complies with the posted security requirements under NRS 108.2403 and 108.2407. Furthermore, landlords should include in their lease agreements a provision that all contracts for labor, services and materials for tenant improvements are subject to the review and approval of the landlord. This provides the landlord with the opportunity to make sure the tenant has complied with the posted security requirements before work is allowed to commence.

Michael Pagni is a partner with the law firm of McDonald Carano Wilson in Reno, where he specializes in real estate and land-use planning and business entities and transactions. Contact him through www.mcdonaldcarano.com.