Credit Managers are routinely faced with the decision of how, when and whether to issue a release of their mechanics' lien, stop notice and bond rights to effectuate payment. In order to receive payment, the owner, general contractor or subcontractor of a public or private work of improvement will, in almost every instance, require that an executed lien release be given before payment is made. A creditor, however, does not want to release its lien before payment has been made. Although the requirements for lien releases vary from state to state, some jurisdictions have enacted statutes that are intended to protect lienholders from unintentionally waiving lien rights, while still providing owners and construction lenders with some certainty of payment.
For example, in Arizona and California, the state legislatures have enacted statutes that protect lienholders by requiring specific formalities to be followed before lien releases will be valid. (See California Civil Code §3262(d) and Arizona Revised Statutes $33-1008). In addition, Arizona, California and other jurisdictions have provided for different types of lien releases depending on how payment is made. A conditional release is routinely given in exchange for payment made by a regular check or when a release is required before payment will be made. An unconditional release, on the other hand, is given when a creditor has been paid in full, unconditionally. Additional requirements exist for progress payments and final payments. Thus, it would seem that in states where the process of releasing lien rights has been set forth by statute, the decision is easy; a lienholder needs only to determine whether the Hen release is conditional or unconditional and for a progress payment or a final payment.
Oftentimes, however, owners, general contractors or subcontractors hold a payment hostage unless and until they receive the release they want, despite the comprehensive statutory scheme. It is not unusual for an owner, general contractor or subcontractor to demand an unconditional release before payment will be made, despite the fact that payment will be made by a regular check that can easily be returned unpaid for non-sufficient funds. The decision to issue an unconditional release when a conditional release is warranted could mean the difference between preserving a creditor's mechanics' lien, stop notice and bond rights or losing them completely when a check bounces or when payment has not been received. One recent court opinion illustrates the danger of issuing an unconditional lien release when a conditional lien release is warranted.
The JWJ Contracting, Inc. Opinion
In Endo Steel, Inc. v. Janas (In re JWJ Contracting Co., Inc.) 371 P. 3d 1079 (9th Cir. 2004), the United States Court of Appeals for the Ninth Circuit affirmed a lower court's holding that a payment made to a subcontractor, Endo Steel, Inc., within 90 days of the general contractor's bankruptcy petition, was a preference. This determination turned on the type of lien release issued by the subcontractor.
The City of Phoenix retained JWJ as the general contractor for its public work of improvement to the Sky Harbor International Airport. As required by state law, JWJ obtained a payment bond that guaranteed payment to subcontractors and suppliers. JWJ subcontracted with Endo Steel to supply and install steel reinforcing bars required for the project. On April 14, 1994, JWJ issued a check to Endo Steel for the sum of $194,286.71 as payment for work performed and material supplied by Endo Steel. Upon receipt of the check, Endo Steel issued an unconditional release of lien in accordance with Arizona Revised Statutes §33-1008.
The check was dishonored for non-sufficient funds and, upon demand by Endo Steel, JWJ issued a cashier's check 19 days later (May 2, 1994) for the full amount. JWJ's bankruptcy petition was filed on July 1, 1994.
Preference Actions Under 11 USC §547(b) And The 'Contemporeneous Exchange' Exception
Under federal bankruptcy law, if a debtor pays a debt incurred within 90 days of the filing of a bankruptcy petition, the bankruptcy trustee may avoid the payment by instituting a preference action. …