Chapter VI Public Policy Issues

• Library: Turner on Illinois Mechanics Liens (2016 Ed.)

CHAPTER VI - PUBLIC POLICY ISSUES

By Howard M. Turner & Michael T. Nigro

As was mentioned in the Introduction to this book, for 140 years the Mechanics Lien Act has been a political football. It is still a political football. The main conflicts are between the following groups: (a) lenders and their title insurers; (b) contractors; (c) owners; (d) subcontractors; and (e) sureties. In the last 25 years, there have been major battles that were fought in the legislature and the courts on the following issues:

1. The validity and interpretation of "pay if paid" clauses that deprive a subcontractor of a remedy if the contractor is not paid.
2. The validity of "no lien" contracts and clauses subordinating mechanics liens to mortgages.
3. Whether a contract is void if the lien claimant did not have the required license or permit thus making the lien claim invalid.
4. Whether work must be completed within either three or five years after the performance of the work is commenced as provided in Section 6 of the Act and what that means.
5. Whether the lien claimants or the lenders have priority to the part of the proceeds of the sale of the real estate that represents the value of the improvements made by the contractor and its subcontractors.

In addition, there was an issue of whether The Employee Retirement Income Security Act (ERISA) preempted the Mechanics Lien Act. The Second District Appellate Court said no.¹

A. Pay if Paid Clauses

In Illinois, a "pay if paid" clause in a contract means that the contractee has no obligation to pay the contractor or subcontractor with whom it has a contract unless the contractee gets paid. The "contractee" is the party with whom the contractor or subcontractor has a contract. The case that first enunciated this rule is A.A. Conte, Inc. v. Campbell-Lowrie-Lautermilch Corp.² The suit was brought by a subcontractor against a contractor. The subcontract provided:

ARTICLE 5: Material invoices submitted before the 25th of the current month will be paid by the 28th of the following month, provided the material so delivered is acceptable, and if payment for invoiced material has been received by Campbell-Lowrie-Lautermilch Corporation under its general contract. Discountable bills will be paid as stipulated in the order.³ (Emphasis in the original)

The court held that this language made payment to the subcontractor conditioned upon the contractor receiving payment from the owner. As a result, even though the subcontractors had valid liens against the real estate, they could not receive payment either from the contractor or from the proceeds of sale of the property.

Several decisions have narrowed the application of the A.A. Conte decision. If the contractor's acts or omissions are the cause of it not being paid, the "pay if paid" clause will not bar recovery by the subcontractor.⁴ Brown & Kerr Inc. v. St. Paul Fire & Marine Insurance Co.⁵ held that a "pay if paid" clause in a subcontract would not prevent recovery by the subcontractor in a suit on a surety bond because the bond and the subcontract were separate contractual documents with different obligations. Careful drafting can also narrow the consequences of a "pay if paid" clause for a subcontractor.⁶

The Mechanics Lien Act has now been amended to provide that in most situations, a "pay if paid" clause is not a defense to a mechanics lien suit. 770 ILCS 21(e) provides:

Any provision in a contract, agreement, or understanding, when payment from a contractor to a subcontractor or supplier is conditioned upon receipt of the payment from any other party including a private or public owner, shall not be a defense by the party responsible for the payment to a claim brought under Section 21, 22, 23, or 28 of this Act against the party.

Thus, a "pay if paid" clause may not be a defense to a mechanics lien action, but it still may be a defense to a suit in contract by a subcontractor against a contractor.

B. No Lien Contracts and Subordination Clauses

Provisions in contracts that invalidate mechanics liens have had an interesting history. In 1914, the Illinois Supreme Court expressed the view that a statute that prohibited a contract from invalidating mechanics liens would be unconstitutional as violating liberty of contract.⁷ Up until 1992, Section 21 of the Act provided that a "no lien" contract clause in a contractor's contract with the owner was valid against a subcontractor if the subcontractor had constructive notice of the provision at least ten days before it made its subcontract. Notice could come from a recorded document or actual notice.⁸ In 1992, the Act was amended to make "no lien" clauses in contracts unenforceable. The Act was amended to provide:

An agreement to waive any right to enforce or claim any lien under this Act where the agreement is in anticipation of and in consideration for the awarding of a contract or subcontract, either express or implied, to perform work or supply materials for an improvement upon real property is against public policy and unenforceable. This Section does not prohibit release of lien under subsection (b) of Section 35 of this Act or prohibit subordination of the lien, except as provided in Section 21.⁹

This provision is now 770 ILCS 60/1(d). The provision was held enforceable by the Illinois Supreme Court in 1998.¹⁰

On July 14, 2014, 770 ILCS 60/1(d) was amended to prohibit agreements subordinating mechanics lien claims except "an agreement to subordinate a mechanics lien to a mortgage lien that secures a construction loan if that agreement is made after more than 50% of the loan has been disbursed to fund improvements to the property." The amended statute does not say who must agree to the subordination. It only states that the subordination agreement must be made after more than 50% of the loan has been disbursed to fund improvements. The liens of the contractor and subcontractor arise as of the date of the contractor's contract with the owner. Therefore, in most cases, the liens of contractors and subcontractors will be in existence when an agreement to subordinate liens can be validly made.

Mechanics liens are property rights that are protected by the Constitutions of the United States and the State of Illinois.¹¹ Therefore, a lender will need to get each contractor and subcontractor to consent to the subordination agreement. Non-consenting contractors and subcontractors will not be bound by the subordination agreement. The owner and lender may have to make a deal with each contractor or subcontractor to subordinate its lien rights. It is unlikely that subcontractors will agree to subordination agreements unless they receive assurance of payment. Therefore, unless a bond or some other guaranty of payment is made, it is unlikely that subordination agreements will be of much use to lenders and title companies.

C. Is the Contract Invalid Because it Is Unlawful?

Douglas Lumber Co. v. Chicago Home for Incurables,¹² states that a provision in a municipal ordinance that requires a license to do certain kinds of work does not usually mean that unlicensed persons cannot perform the work. But architects may not have valid contracts if they do not have proper licenses to practice their professions in Illinois. An architect who is not licensed to practice architecture in Illinois cannot make a valid contract to provide architectural services, and if an architect's contract is invalid because it lacks a license, the architect cannot have a valid mechanics lien.¹³

A contract is not invalid merely because an act performed pursuant to the contract is unlawful. The contract is only invalid if it "contemplates an illegal act or necessarily involves a violation of law." See Pascal P. Paddock, Inc. v. Glennon.¹⁴

The latest Supreme Court case to address the issue of whether a contract is invalid if it violates a statute is K. Miller Const. Co. v. McGinnis.¹⁵ There the Supreme Court broadened the rule in Pascal P. Paddock, Inc. v. Glennon holding that public policy considerations ultimately determine whether a statutory violation makes a contract unenforceable. The Court said:

Importantly, the fact that there has been a statutory violation does not, in itself, automatically render a contract unenforceable: "The strength of the public policy involved is a critical factor in the balancing process. Even when the policy is one manifested by legislation, it may be too insubstantial to outweigh the interest in the enforcement of the term in question." The decision of whether and how to enforce a contract involving a prohibited performance is and must be based on policy choices and a balancing of relevant factors. Illinois law is in accord with the Restatement. . . . [A] statutory violation does not automatically render a contract unenforceable: "the mere fact that [a contract] was performed in violation of law will not invalidate the resulting lien if not seriously injurious to the public order." Paddock, 32 Ill. 2d at 53-54, 203 N.E.2d 421. Merely because a contract may violate some law or some regulation does not necessarily make that contract unenforceable. [N]ot all violations of law brought about in the performance of a contract are considered serious enough to prevent recovery on the contract by the party who violates the law.

D. When Must the Work Be Completed?

Section 6 of the Act was amended effective January 1, 2013, to provide that work must be completed on residential property within 3 years after it beginsand as to other types of property within 5 years after the work begins. Section 6 states:

In no event shall it be necessary to fix or stipulate in any contract a time for the completion or a time for payment in order to obtain a lien under this act, provided, that the work is done or material furnished within three years from the commencement of said work or the commencement of furnishing said material in the case of work done or material furnished as to residential property; and within 5 years from

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