Carlson Dash Likely Obtains First Order Substituting Bond for Mechanic’s Lien

Effective on January 1, 2016, Illinois became the 50th and last state to permit a party to “bond over” a mechanic’s lien. On January 28, 2016, on behalf of our contractor client, our firm successfully obtained what likely was the very first order approving a bond under the new section 38.1 of the Illinois Mechanics Lien Act that permits an owner, contractor or other upstream party to substitute the bond for the claim for mechanic’s lien.[1]  The order was filed with the Lake County Recorder’s office that same day and provides that the “lien claim … is now secured by this bond and is no longer a lien on the land …,” effectively taking the owner and its lender out of the lawsuit equation.

The decision to seek this bond was driven by the circumstances of the particular case.  Is such a bond desirable in all cases?  Surely not.  We identify below some of the factors that should be considered when deciding whether or not to seek such a bond.

Is the client bondable?

The Section 38.1 bond is required to be issued by an “eligible surety company,” which means by statute that it must have at least an “A” rating without any modifiers and a financial size category of not less than IX with A.M. Best Company, Inc.  Further, the bond must be in the amount of 175% of the principal amount of the mechanic’s lien claim.  Getting a bond without a pre-existing relationship with a surety – and having gone through underwriting in advance – can be problematic, even if you are ready, willing and able to post 100% cash as collateral to secure the surety.  And let’s face it: who really wants to put up 175% cash as collateral, especially as the numbers get bigger?

In what position do you sit?

Is the client an owner, an upstream contractor or a lender?  If it is an owner, the mortgage lender may be lobbying (forcing) it to get one of these bonds, but this type of a bond will not always be the right choice for the situation.  Therefore, it is very important when negotiating the mortgage that the owner have discretion to post an alternative financial accommodation, such as a letter of credit or a common-law “lien bond.”  Similarly, the original (often general) contractor should reserve this discretion in its construction contract, as should every subcontractor that is not a pure material supplier.  There may be circumstances in which a lender might want to obtain this kind of a bond as well, i.e., when the owner becomes financially unable to pay its mortgage, but other factors (including those below) should be taken into account.

How well do you know the dispute and what are its merits?  

If the client is a direct party to the dispute and you know that the claimant is off its rocker – and is solvent, the statutory bond does offer the prospect of attorneys’ fees in the event that the claimant fails to recover at least 25% of the amount of its lien claim.  On the other hand, if the claimant recovers 75% or more of its lien claim, it may recover attorneys’ fees up to the amount left in the bond.

This puts particular risk on an owner or upstream contractor who is compelled to obtain the statutory bond under its mortgage or contract but is not a party to the dispute.  For example, suppose a mortgage requires an owner to procure a statutory bond in the event of a mechanic’s lien claim and the dispute is between the contractor and a subcontractor but the contractor is unwilling or unable to respond.  The owner may not be in a position to judge the merits when the mortgagee forces the issue.  If the owner obtains the statutory bond and the claimant is the prevailing party, the bond will be used to fund not only the full principal amount of the judgment, but also the statutory interest and the claimant’s attorneys’ fees up to the full amount of the bond.

This risk is not a one-way street.  Suppose a subcontractor timely serves notice of a claim and records a claim for lien in the real property records, confident that it is owed money under its contract.  An owner obtains a section 38.1 bond, knowing that it has disbursed fully in accordance with the sworn statements delivered to it until it received the subcontractor’s notice.  The subcontractor engages in discovery, only to find out that the owner likely has a valid “proper payment defense” under section 27 of the Act.  The breach of contract claim might be 100% successful, but the claimant may nevertheless have to pay the owner’s legal fees because the amount of the lien claim could be zero.

What does the future hold?

There are many details to this statute, some of which will be noted in future posts on our website.  Further, as discussions and cases progress, there is no doubt that we will continue to find issues that the legislature did not contemplate that will need to be fixed.  The best place to come for advice on such bonds is right here: Carlson Dash, LLC.

[1]  There is a 30-day objection period that must pass absent an agreement of the parties – which we obtained.  While it is possible that another bond was approved at an earlier date, we are not aware of any.

This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.

James M. Dash | Real Estate Litigation, including Title Defense, Construction and Mechanic’s Liens

Jim concentrates his practice in real estate-related litigation, with an emphasis on construction (including mechanics lien claims), as well as title insurance defense work. If you need assistance with a related matter, contact Jim.