Dot Com Bust Leads To Favorable Result For Tenant Improvement Contractors

Dot Com Bust
Leads To Favorable Result
For Tenant Improvement Contractors
- An Overview of Notices of Nonresponsibility -

By William C. Last, Jr., Esq.

A February 14, 2003 California appellate decision favoring tenant improvement contractors, has narrowed the protection against mechanic’s liens afforded by a landlord’s Notice of Nonresponsibility.

In Howard S. Wright Construction Co. v. Superior Court ((2003) 2003 Cal. App. LEXIS 230) the Howard S. Wright Construction Co. (HWCC) brought a lawsuit to foreclose a $2.4 million mechanic's lien on property owned by real party in interest, BBIC Investors, LLC (BBIC). BBIC had leased the property to 360networks which subsequently filed bankruptcy. The construction work performed by HWCC consisted of improvements to convert the property from a warehouse into an adequate facility for 360network's telecommunications business.

BBIC filed a motion that sought an order "removing" the HWCC mechanic's lien. The motion to remove the lien, relying Lambert v. Superior Court ((1991) 228 Cal. App. 3d 383, 279 Cal. Rptr. 32.), was filed early in the procedural history of the case and sought to challenge the validity of the mechanic’s lien. Since 1991, attorneys have used the Lambert case to challenge the validity of a mechanic’s lien and used these motions to remove a mechanic's lien, allowing the property owners to obtain speedy relief from an unjustified lien or a lien of an unjustified amount without waiting for trial on the action to foreclose the lien. In the Howard S. Wright case, the Superior Court granted the motion to remove the lien. The contractor subsequently appealed the Superior Court’s decision.

The question posed to court was whether BBIC’s properly recorded and posted Notice of Nonresponsibility barred HWCC from asserting a mechanic’s lien. The appellate court answered: “no” and reasoned that because the owner, BBIC, “participated” in the construction, their Notice of Nonresponsibility was invalid.

Notice of Nonresponsibility Overview

Pursuant to California law, contractors, subcontractors, laborers and materialmen have a mechanic’s lien on real property upon which they have bestowed labor or furnished materials if the labor or materials were furnished “at the instance of the owner” or the owner’s agent. If a tenant requests the labor or materials and the landlord is unaware of the work, then mechanic’s lien only attaches to the tenant’s leasehold interest in the property. If an owner/landlord has express or actual knowledge of the construction work taking place on its property it is deemed to have work done under its "instance" and hence is "under direct contract" with the contractor even though its tenant contracted for the work. As a result a mechanic lien can affect the owner’s interest in the property. However, a non-contracting and non-participating owner/landlord who records and posts a Notice of Nonresponsibility should be able to prevent the lien from attaching to their interest in the property (but not the actual improvements). Before examining how the Participating Owner Doctrine affects these general principles, we should review the requirements for a valid Notice of Nonresponsibility.

Under California Civil Code section 3094: “[a] Notice of Nonresponsibility means a written notice, signed and verified by a person owning or claiming an interest in the site who has not caused the work of improvement to be performed, or his agent, containing all of the following:

  1. A description of the site sufficient for identification.
  2. The name and nature of the title or interest of the person giving the notice.
  3. The name of the purchaser under contract, if any, or lessee, if known.
  4. A statement that the person giving the notice will not be responsible for any claims arising from the work of improvement.

Within 10 days after the person claiming the benefits of nonresponsibility has obtained knowledge of the work of improvement, the notice provided for in this section shall be posted in some conspicuous place on the site. Within the same 10-day period provided for the posting of the notice, the notice shall be recorded in the office of the county recorder of the county in which the site or some part thereof is located.” (Emphasis added) If the owner/landlord fails to comply with the requirements of the statute, the notice will be rendered ineffective.

Over the years the California courts have created a Participating Owner Doctrine that avoids the harsh effect on a contractor’s lien rights resulting from the recordation and posting of a Notice of Nonresponsibility. The owner’s ability to avoid the effect of a mechanics lien by using a Notice of Nonresponsibility is dependent on his involvement or “participation” in the work of improvement. Generally, a participating but non-contracting owner is a landlord involved with the project to such an extent, they can no longer prevent a lien from attaching by posting a Notice of Non-Responsibility.

The Wright case helps TI Contractors

The decision rendered by Howard S. Wright decision fortified the Participating Owner Doctrine and cited a number of examples of participating owners. For example, in one case referenced in Wright, a lease contemplated renovation of an obsolete movie theater, acknowledged that alterations were to be made, required the lessor's approval of the plans and specifications and provided for the lessor's monthly contributions to the costs of the alterations, the result was a finding that the Notice of Nonresponsibility was invalid. That court’s decision reasoned the lessee was obligated to make the alterations and improvements as a condition to the effectiveness of the lease, thus the lease was more in the form of a joint venture between the owner and the lessee.

In another appellate court case cited by Wright, the lease for a parcel of unimproved property near a freeway, provided that the premises were to be used only for a service station and restaurant, that construction was to begin within 120 days and that the rent was to be based on a percentage of the gross income from the products and services sold on the property. The court also found that the lease "intended to (and probably did) accomplish substantial benefit to both his present and future interest in what was then vacant property." As a result of such participation by the landlord the Notice of Nonresponsibility was invalid.

In Wright, the evidence demonstrated that significant specialized improvements were required before the high tech tenant could use the property. The evidence also revealed that the lease required the tenant to obtain landlord’s approval of the plans and specifications of its initial alterations and the landlord collected an administrative fee of $5,000 per month for overseeing the construction. Clearly, the landlord would be able to charge more rent after improving a dated warehouse to a technologically advanced space. When the technology boom crashed, so did BBIC’s tenant. Left with a bankrupt tenant, BBIC’s profitable lease evaporated and they were hoping to avoid having to pay for the leasehold improvements constructed by Wright.

The Wright trial court ruled the contractor failed to prove BBIC was a participating owner because: "(Wright) has not shown any of the following: (a) that the tenant acted as (BBIC’s) agent; (b) that the lease obligated the tenant to make any particular improvements; (c) that the tenant was to be repaid from rental income for the costs of the improvements; or (d) that the tenant's rental payments were based on a percentage of the income from the business for which construction of the improvements at issue was required. Although it is true that the lease provides that Defendant's consent was required prior to any improvements being made to the premises, the Court finds that such is not sufficient to treat Defendant as a participating owner under the circumstances of this case."

The Wright appellate court disagreed based on three key factors that lead it to conclude that Participating Owner Doctrine was applicable. First, the tenant need not be the landlord’s agent. The Court stated: “For purposes of the participating owner doctrine, the tenant need not act as the landlord's actual or ostensible agent; the tenant becomes the agent of the landlord "by implication of law" when the lease requires the tenant to make the improvements.” Second, the Court found that the fact that the lease did not require any particular improvements is not determinative. The Court stated: “The question is whether the improvements were a practical necessity for the contemplated use of the premises.” Third, the Court did not seem deterred by the absence of any cost-sharing or profit-sharing arrangement between the landlord and tenant which was a common thread in the earlier appellate court cases. Since the landlord in the Wright case stood to benefit from the higher rent made possible by the improvements, the Wright court concluded that the financial relationship between the landlord and tenant still existed but in a different form than the earlier appellate court cases.

Suggestions

Require a payment bond. If you are contracting to perform tenant improvement work directly with a tenant, you should require the tenant or the general contractor to obtain a payment bond.

Note the date and location of any Notice of Nonresponsibility. When you become aware of Notice of Non-Responsibility, remember to note the date you first learned of it and the location of the Notice. Next, confirm that a payment bond is in effect. If there is no payment bond, you should closely monitor the contract payments.

If it becomes necessary to file a mechanics lien, ask a construction lawyer to review the facts to determine the effectiveness of any Notice of Nonresponsibility posted by the owner or landlord. It is not uncommon to discover that an owner has participated in the work of improvement and/or failed to follow the statutory requirements.

Finally, the decision in the Wright case is a reminder that if the validity of a mechanic’s lien is in question, it is possible to obtain speedy relief from an unjustified lien or a lien of an unjustified amount without waiting for trial on the action to foreclose the lien. This option is available to any party who is impacted by the lien and wants to challenge its merit. Perhaps in another article, I’ll discuss the many situations where questionable stop notices and payment bond claims can be challenged at an early stage in the litigation process.

©2003 This article was written by attorney William C. Last, Jr. Bill Last has specialized in Construction Law for more than 24 years and represents contractors throughout California. Bill holds a California “A” and “B” license and is active in a number of construction trade associations. He can be contacted at 415-764-1990 or 650-425-7679. A number of his past articles can be found on his website (www.lhfconstructlaw.com). This bulletin is published periodically to provide general information about current legal issues. The articles are not intended to be a substitute for the advice of an attorney as to a specific problem. If you have a specific legal question or need legal advice, you should contact an attorney.