General Contractors Should Beware of Subordination Agreements

Lien waivers are critical in construction payments, and general contractors are typically required to subordinate their mechanic's lien rights to lenders. Mechanic's liens can have a negative impact on cash flow and in some cases can force double payments. With the current economic climate, construction projects have faced more hardships and companies have seen tighter cash flow. Higher interest rates, inflation and a looming recession all point to an increased likelihood of lien rights being enforced. So, what fallout comes along with these challenges?

Foreclosures, bankruptcies and payment delays are all possible outcomes for contractors without the protection of their mechanic's lien rights. "If the general contractor's lien rights are subordinate to the lender, it limits the abilities of the general contractor to push cash through," said Chris Ring of NACM's Secured Transaction Services. "It may escalate the potential need for someone to file a lien and can even trigger more bankruptcies." And in the event of a recession, lawsuits are more likely to be initiated for closure action, Ring added. "Because of the general contractor's subordinate lien rights behind a lender, it makes the lawsuit less advantageous."

Despite potential challenges, general contractors can still put themselves in an advantaged position. One way is to review current progress payment procedures in detail to make sure those payments will not be delayed. "This is something to remind our primary members (material suppliers selling to subcontractors) who are a bit further down the food chain," said Ring. "They may or may not be aware that the general contractor has subordinate lien rights to the lender, but they should always assume that they do."

Another way for general contractors to put themselves in a better position is to ensure change order procedures are understood by all parties involved to eliminate any confusion on what documentation will be required in the change order. "Unfortunately, most people don't realize these transactions happen and assume the general contractor can file a lien," Ring said. "In many cases, they can't because their lien rights are going to be subordinate to the primary lender."

A clear definition of the general contractor's rights and conditions of the lender for disbursement of retainage are essential. California laws have held subordination agreements which are "enforceable as long as the agreement to subordinate is clearly laid out, and the general contractor knowingly waived its mechanic's lien rights," reads an article from JD Supra. Despite said laws, general contractors should still consider these forms of protection to waive their rights.

-Kendall Payton, editorial associate

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Monday, 27 May 2024

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