Chapter VIII Payouts, Waivers, Sworn Statements, Statutory and Constructive Trusts, and Wrongful Payments

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

CHAPTER VIII - PAYOUTS, WAIVERS, SWORN STATEMENTS, STATUTORY AND CONSTRUCTIVE TRUSTS, AND WRONGFUL PAYMENTS

A. The Applicable Statutory Law

Most construction contracts and subcontracts have provisions governing payment procedures. But in addition, the Mechanics Lien Act must be followed. It is a part of every contract between an owner and a contractor.¹ The requirements of Sections 5, 21, 22, 27, and 32 of the Act are especially important.² They determining the rights and liabilities of the parties when payments are made or are to be made to the contractor, subcontractors, and secondary subcontractors.

B. The General Concept

In Weather-Tite, Inc. v. Univ. of St. Francis,³ and Gerdau Ameristeel US, Inc. v. Broeren Russo Const., Inc.,⁴ these courts said the following:

[T]he legislature intended the following orderly method of conducting construction transactions to protect subcontractor claims:

(1) the owner and the general contractor enter into a contract for the construction work;
(2) as the work is completed, the general contractor submits a section 5 sworn affidavit that must list all subcontractors and the amount due, to become due, or advanced;
(3) when the section 5 sworn affidavit lists an amount due or to become due a subcontractor, section 24 requires the owner retain sufficient funds to pay the subcontractor; and
(4) section 27 requires the owner to make subcontractor payments upon receiving notice of a subcontractor claim pursuant to a section 5 sworn statement. Additionally, a lien waiver can be provided to the contractor when the subcontractor is paid, and the owner can require a lien waiver by every subcontractor when paying the contractor. Funds subject to a lien waiver are required to be held by the owner in trust for the subcontractor.

C. The Impact of the Weather-Tite Case

The method for payment specified by the Supreme Court in Weather-Tite does not encourage direct payments by the owner to the contractor. Many attorneys, banks, and title companies were surprised by Weather-Tite. The owner and contractor in that case followed a then common practice. The owner paid the money to the contractor so that contractor could pay the subcontractors listed on the contractor's sworn statement. The contractor deposited the money in his bank account and intended to use the money to pay its subcontractors. But instead, the bank took the money and applied it to a debt owed to the bank by the contractor. The subcontractors remained unpaid.

There was a column in the statement given by the contractor to the owner headed "This Payment." This column listed the amount each subcontractor was to receive. The contractor was to pay the subcontractors from the payment it received from the owner. The Supreme Court held that the "This Payment" column charged the owner with notice of the amounts that were due the subcontractors and, therefore, the owner had a duty to withhold sufficient funds from the contractor to see that the subcontractors were paid.⁵ The Supreme Court held that the owner violated Section 27 of the Act by paying the money to the contractor rather than to the subcontractors⁶ who were listed on the statement given to the owner. Even though the statement was not sworn, the Supreme Court said that it was sufficient to give the owner notice of the amounts due the subcontractors.⁷ But in order for an unsworn statement to satisfy the requirements of the Act, the owner must actually rely upon it.⁸

The problem for parties using national forms of contract and using commonly accepted national procedures for payment is that Illinois mechanics lien law is unique. As pointed out in the introduction to this book, the Illinois Supreme Court has stated that Illinois mechanics lien law is unique, and decisions in other states are not instructive as to its interpretation.⁹ Some years ago a subcommittee of the Chicago Bar Association's Mechanics Lien Subcommittee prepared a rider for the AIA¹⁰ construction contract forms to deal with the differences in Illinois law. AIA refused to accept any local modification. Therefore, attorneys should be very cautious in using AIA forms and should modify them to comply with Illinois law.

D. How to Make Lawful Payments

Many owners have relied primarily on waivers of lien from the contractors and subcontractors to protect themselves from mechanics lien claims. As will be explained later, relying on a lien waiver is dangerous unless there is actual proof that the subcontractor was paid. There is no statutory right to rely on a waiver of lien. The owner only has a statutory right to rely upon sworn statements from contractors that comply with Section 5 of the Act and sworn statements from subcontractors that comply with Section 22 of the Act. Currently, the Fidelity Group of title companies only honors a waiver of lien if they have clear proof that the amount of the waiver has, in fact, been paid.

Section 5 authorizes the owner to require that, before payment is made, the contractor furnish the owner with a sworn statement listing its subcontractors and containing information required by the statute. This statement is the key means by which an owner can protect itself against mechanics liens and avoid paying subcontractors after previously paying the contractor. Sworn statements are serious business. A false sworn statement can subject the maker to criminal charges of perjury, and it can also have disastrous civil consequences. In one case, the president of a subcontractor who gave a false sworn statement to a contractor not listing its secondary subcontractors was denied a discharge in bankruptcy from her personal liability to the contractor.¹¹

To make a lawful payment, the owner, lender, or escrowee should first obtain a sworn statement from the contractor that complies with Section 5 of the Act. The owner should next obtain sworn statements complying with Section 22 from the subcontractors listed on the contractor's Section 5 sworn statement. Payments should then be made to the persons who are entitled to receive them based upon the affidavits. New sworn statements should be obtained for each separate draw of funds to pay the contractor and subcontractors.¹²

The owner has a statutory right to rely upon a sworn statement from the contractor if it conforms to the statute and is not otherwise invalid or fraudulent. A sworn statement under Section 5 must be:

(a) in writing;
(b) under oath or verified by affidavit;¹³
(c) contain the names and addresses of all parties furnishing labor, services, material, fixtures, apparatus or machinery, forms or form work; and
(d) state the amounts due or to become due to each.¹⁴

A good form to use is the current Chicago Title Insurance Company form.¹⁵ That form contains more information than Section 5 requires, but it is better to overstate than understate. The form requires:

(a) the names and addresses of subcontractors;
(b) the trade;
(c) the subcontract amount;
(d) the amount previously paid; and
(e) the balance due or to become due.

It is essential that a sworn statement contain the information required by Section 5 of the Act. An owner, lender, or title insurance company should never accept a sworn statement that states "all material taken from fully paid stock" or "our principal supplier is." Acceptance of this kind of language may conclusively expose an owner to paying twice.¹⁶ The author has, with a minimum of effort, won several motions for summary judgment representing lien claimants against owners solely on the basis that the sworn statement used this kind of language and did not provide the information required by Section 5. In Brennan v. William P. McEvoy & Co.,¹⁷ the sworn statement did not make it clear whether a party listed was a subcontractor or merely a bidder. Because the statement did not make it clear what was due or to become due to the subcontractors, the statement was ineffective.

The use of language which makes the owner liable for wrongful payment is very common. The following quotation from Fred C. Kramer Co. v. La Salle Nat. Bank,¹⁸ shows how wrong this practice is.

In Ceco Steel Products Corp. v. Couri, 311 Ill. App. 297, 35 N.E.2d 810 (1941), "the only question," said the court (p. 298, 35 N.E.2d 810), "is whether the affidavit is a sufficient compliance with the mechanic's lien statute, so as to bar the claim of the plaintiff for a lien." After quoting sections 5 and 32 in full, the court said (pp. 300-301, 35 N.E.2d p. 811):
" . . . [I]n Section 5 it says that the statement in writing shall contain 'The names of all parties furnishing materials and labor, and. . . the amount due or to become due each.' The pertinent part of the affidavit . . . states: 'affiant further says that the materials used for said Edward Couri belonged to us and were our exclusive property, no one having any interest or claim therein, and that all of the labor was paid by us.' This is not a compliance with the statute. . . . The affidavit is defective in not stating from whom Dornon and Fidler purchased the material, and whether it had been paid for." (Emphasis added).

E. If an Owner Pays Without Getting a Sworn Statement it does so at its Peril

The purpose of the contractor's Section 5 sworn statement is to protect owners from the claims of unknown subcontractors.¹⁹ To protect itself from paying twice for the same work, the owner must demand from the contractor, prior to payment, a sworn statement listing all subcontractors providing labor and materials to the contractor. If the owner pays the contractor before receiving the sworn statement, the owner may be compelled to pay subcontractors even if it has paid the contractor in full. If the owner pays the contractor without holding back enough money to pay a subcontractor after the owner receives notice that an amount is due or to become due the subcontractor, the owner may have made a wrongful payment. The notice may be either through a statement furnished by the contractor to the owner,²⁰ or...