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How to Protect Yourself from Liability as a Property Owner and how to Secure Payment as a Contractor

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WHEN TENANT IMPROVEMENT PROJECTS FAIL:
HOW TO PROTECT YOURSELF FROM LIABILITY AS A PROPERTY OWNER AND HOW TO SECURE PAYMENT AS A CONTRACTOR
As insolvent tenants closed their doors, contractors pursued their mechanic’s lien rights against the owners to recover damages. Contractors often discovered that owners had filed bankruptcy or that their liens did not have priority over other encumbrances recorded against the property, leaving little to no recovery for the contractor. As owners and contractors are both subject to harm by property tenants who implement a work of improvement to a leased space, it is important that all parties involved protect their interests when dealing with tenant improvement projects. Tenant improvement projects can potentially subject owners of commercial properties to mechanic’s lien claims. Generally, if a contractor does not receive payment for work performed or materials supplied to a project, the contractor can secure payment by recording a mechanic’s lien pursuant to NRS Chapter 108. A lien claimant is defined as anyone who provides work, material or equipment in excess of $500, used in or for the construction,
BY MARISA MASKAS, ESQ.
It is no secret that the construction industry in Nevada took a huge hit after the 2008 recession. There are vacant strip malls and empty office complexes scattered throughout the state. The economic collapse sent many companies into financial turmoil. In the midst of settling into new office spaces, new businesses were forced to halt the construction of ongoing tenant improvement projects. Many projects went over budget, and funding ultimately failed, causing tenants to default on their leased space and leaving contractors to deal with collecting money owed for work performed.
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alteration or repair of any improvement, property or work of improvement. If a contractor, subcontractor or materials supplier does not receive payment for labor or materials supplied to a property, it can record a lien on that property in the amount of the unpaid balance of the agreed-upon price for such work, material or equipment, “whether performed, furnished or to be performed or furnished at the instance of the owner or his agent.” All improvements to a property are deemed to have been constructed “at the instance of each owner.” NRS 108.234(1). A mechanic’s lien is intended to ensure that contractors and suppliers are provided with a mechanism to recover payment for work performed on a property. However, even though a contractor may follow the requirements to perfect a mechanic’s lien, an owner can protect itself from potential lien claims caused by a tenant’s failure to pay for the construction to the property by requiring the tenant to post security for the tenant improvement as required by NRS 108.2403(1) and recording a Notice of NonResponsibility on the property, if the owner otherwise qualifies as a “disinterested owner” under NRS 108.234(7). With very limited exceptions, Nevada law requires that a tenant post security prior to causing a work of improvement one of two ways: either by obtaining a tenant improvement bond or by establishing a construction disbursement account. First, a tenant can obtain a tenant improvement bond (T.I. bond), as outlined in NRS 108.2403(1)(b)(2). T.I. bonds are similar to payment bonds obtained and required for public works projects that provide protection to unpaid claimants on a project. A T.I. bond must comply with the requirements of 108.2415, including: recording the bond with the county recorder of the county where the property is located, upon which the improvement is, or will be, constructed, altered or repaired; the bond must be in an amount no less than 1.5 times the amount of the construction contract; and each person who gives the lessee the notice of right to lien must receive notice of the recording of the surety bond within 10 days after receipt of the notice of right to lien. In the alternative, a tenant can post the required security by establishing and funding a construction disbursement account. NRS 108.2403(1)(b)(1) sets forth the following requirements that the tenant must follow: 1. The account must be funded by the lessee, in an “amount equal to the total cost of the work of improvement but in no event less than the total amount of the prime contract”; 2. The lessee must obtain the services of a construction control to administer the construction disbursement account; and 3. The lessee must notify each person who gives the lessee a notice of right to lien of the construction disbursement account within 10 days after receipt of the notice of right to lien. Once a tenant deposits funds into the account, the general contractor can submit invoices for payment to the construction control company. Once the company verifies the work is complete and is in receipt of all required waivers, the contractor is paid directly from the fund. When construction costs exceed the amount in the account, the contractor and
those who served a notice of right to lien are be notified by the company. NRS 108.2407(c). If construction control fails to comply with any requirements, they can be held liable for damages caused to any lien claimants. 108.2407(10). The notice of posted security, whether it is a T.I. bond or a construction disbursement account, must also identify: 1. The name and address of the lessee; 2. The location of the improvement, the address, a legal description and assessor’s parcel number of the property upon which the improvement is or will be constructed, altered or repaired; 3. The nature of the lessee’s interest in the property upon which the improvement is or will be constructed, altered or repaired; and 4. The improvement on such property. NRS 108.2403(2). If the posted security is a T.I. bond, the tenant must include: 1. The name and address of the surety; 2. The surety bond number; 3. The date the bond was recorded; 4. The book and the instrument or document number of the recorded surety bond; and 5. A copy of the recorded surety bond with the notice of posted security. NRS 108.2403(2)(e). If the posted security is a construction disbursement account, the tenant must include: 1. The name and address of the construction control; 2. The date that the lessee obtained the services of the construction control: 3. The total amount of funds in the construction disbursement account; and 4. The number of the construction disbursement account, if any. NRS 108.2403(2)(d). Should a tenant fail to post security as required, a general contractor can stop work on the project; a tenant then has 25 days to post the required security. If that does not happen, a contractor can terminate its contract and the contractor, subcontractors and suppliers involved can all recover the cost of all work, materials and equipment, including any overhead and profit earned through the date of termination, plus the profit that would have been earned if the contract was not terminated. Interest, costs and attorney’s fees incurred pursuant to NRS 108.237 are also recoverable. Once the tenant has provided the posted security, if the tenant’s landlord qualifies as a disinterested owner under NRS 108.234(7), it may record a Notice of Non-Responsibility by following specific requirements set forth in NRS 108.234. A “disinterested owner” is a landlord that 1) does not waive its right to record a notice of non-responsibility under NRS 108.2405, 2) does not personally or through an agent or representative directly or indirectly cause the tenant
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improvement to be performed, and 3) whose tenant has posted security for the tenant improvement under NRS 108.2403. To be valid, a Notice of Non-Responsibility must include the following information: 1. The names and addresses of the disinterested owner and the person who is causing the work of improvement; 2. The property address and legal description; 3. The nature and extent of the disinterested owner’s interest in the improvement and the property upon which the improvement is, or will be, constructed; 4. The date the disinterested owner first learned of the construction; and 5. If the disinterested owner has notified the lessee in writing that the lessee must comply with the requirements of NRS 108.2403. The notice must then be served on the tenant within 10 days of recording and on the general contractor within 10 days after the date on which the tenant contracts with the general contractor. It is then the general contractor’s responsibility to post the notice in an open and conspicuous place on the property within three days of receipt, and serve it, within 10 days, to each potential lien claimant who serves a preliminary notice.
Failure to record a Notice of Non-Responsibility leaves an owner susceptible to potential lien claims and foreclosure litigation should the tenant fail to pay its contractors and suppliers. It is also imperative that an owner comply with the statutory requirements or a Notice of Non-Responsibility could become unenforceable. When properly completed, a Notice of Non-Responsibility can protect an owner from mechanic’s liens. It should also be mentioned that, in some cases, where an owner is involved in the construction or financing of the leased space, a Notice of Non-Responsibility could be considered invalid and will not protect them from liability. While tenant improvements should be handled with caution under any circumstance, owners and contractors can take the necessary steps afforded in NRS 108 to ensure that they are protected.
MARISA MASKAS is an attorney at Pezzillo Lloyd. Her practice focuses primarily in the construction and business law areas. Maskas can be reached at (702) 233-4225 or mmaskas@ pezzillolloyd.com.
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