Mechanics’ Liens: Part 1. The basics of credit risk and subcontracting


[Note: This one of a series of six posts regarding mechanics’ liens:

Part 1. The basics of credit risk and subcontracting.

Part 2. Reallocating risk in construction projects.

Part 3. Acquiring a lien.

Part 4. Enforcing a lien.

Part 5. Personal liability notices.

Part 6. No-lien agreements.]

This starts a short series of blog articles discussing mechanics’ liens and their cousins, notices of personal liability, concepts that arise in the context of construction contracts and similar agreements. To understand what’s special about construction contracts, you need to understand a bit about how contract law, subcontracting, and credit risk work in other settings. So let’s review the basics.

Imagine your company signs an advertising agency agreement, hiring the ad agency to create a television advertising campaign for your business. The ad agency comes up with the ideas for the commercials, hires a production company to produce them, and purchases advertising time on your behalf from local television stations. The contract to produce the commercial is between the ad agency and the production company, but the contract with the television station is between the television station and your company, signed by the ad agency as your company’s agent, as it is authorized to do by the ad agency agreement.

All seems to go well, and you pay the advertising agency the full amount your company owes under the agency agreement, including money that the ad agency is supposed to pay to the television stations on your behalf. Then the advertising agency goes belly-up. It closes its doors, fires all its employees, and files for bankruptcy. Among its unpaid creditors are the production company that produced your commercial and a television station that aired it. Can the production company and the television station force your company to pay them what they should have been received from the ad agency?

Under these facts, there are two different answers. The production company is a subcontractor to the ad agency. It has no claim against your company simply because it does not have a contract with your company. The only thing the production company can do is file a proof of claim in the ad agency’s bankruptcy and hope to recover something.

In contrast, the television station’s contract was with your company, not with the ad agency, and your company is directly responsible for the amount owed to the television station. You’ll have to pay the television station (even though you’ve already paid the ad agency money that was supposed to go to the television station) and hope you can recover something on your company’s own proof of claim in the bankruptcy based on the ad agency’s breach of contract (or some other possible legal theories that we won’t go into).

In producing the commercials without getting paid first, the production company took on the ad agency’s credit risk, and your company does not bear it. However, by paying the ad agency the money the ad agency was supposed to go to the television station, your company took on the ad agency’s credit risk, and that risk does not fall on the television station. In the next blog entry, we’ll examine how mechanics’ liens change that allocation of risk for construction contracts.

If you have an issue with a mechanic’s lien, with a construction contract, or with any other type of contract, please feel free to contact us for an initial consultation with an attorney.

Contact Information