Real estate developers and property owners sometimes make a mistake by entirely outsourcing supervision of the monthly draw process to the title insurer hired by their lenders. But I counsel people against the over-rely on title insurer strategy.
One of the big risks for Illinois project owners and developers is having to pay for the same work twice.
I will not dwell on this point now because it is addressed in videos on my website. But this can happen when they pay the general contractor, and it fails to pay its subcontractors, and then the subcontractors record mechanics liens.
This is not a theoretical concern; this is something that I deal with frequently. The owner can wind up having to pay off the mechanics liens, despite having paid the general contractor for the same work.
So Where Does the Lender’s Title Insurer Fit In?
Now, yes, owners and developers do receive some degree of protection by allowing the title insurer to review the contractor’s and architect’s payment applications, sworn statements, and lien waivers. It’s certainly better than having nobody closely inspect the paperwork.
And yes, developers and property owners are most at risk when they do not know what they are looking for in terms of the content of these documents and they do not get an assist from a title insurer looking out for the project lender.
But usually when monthly project payments are processed through a construction loan escrow – where the title insurer makes disbursements after it is satisfied with the payment documentation submitted – the lender is much more protected than the project owner.
I think this would be news to many Illinois real estate developers and project owners. Many of them over-rely on the construction loan escrow and title insurer review process.
There are a few legal reasons for this, but three stand out as most important.
Project Owners and Developers are Treated Differently Under the Illinois Mechanics Lien Act Than Lenders
Many of the short deadlines we think about when we talk about lien claims – the 90-day subcontractor notice, the four-month deadline to record mechanics liens – are mostly about whether the lien claim, will be able to get priority over the lender’s mortgage interest.
Now this is a very complicated topic, and if we printed up the caselaw in Illinois, it would stack from the floor to the ceiling in my office.
But here is the essence: If mechanics liens are recorded with minor defects, a judge will be much more likely to invalidate the lien and protect the lender’s interest than if only the owner’s interests are at stake.
The reasons are complex, and there are exceptions to every rule, but the basic rationale is that project owners are much closer to the project and they have a much greater ability to protect themselves from liens than third parties like lenders.
So when a title insurer reviews a payment application, it might make certain assumptions and let certain defects slide, knowing that the lender it must protect is likely to receive more favorable treatment in mechanics lien litigation than the project owner.
As someone who has litigated many mechanics lien foreclosure actions, I have gone into court with the “the-lien-is-invalid-with-respect-to-the-lender” argument on more than one occasion.
So project owners and developers who think the lender’s title insurer 100% has their back on payment application review are not 100% wrong – but they may be taking a risk perhaps bigger than they realize.
Real estate developers and project owners should not over-rely on title insurer review, with blind faith, and without satisfying themselves as to who the title insurer is looking to protect. Because often, it is their lender..
The Illinois Mechanics Lien Act Imposes Certain Obligations on Project Owners, As Well As Their Contractors and Design Professionals
This a huge over-simplification, but the Lien Act essentially provides certain “green lights” – which indicate the owner is clear to make payments – and certain “red lights” – which should cause an owner to stop making payments.
Project owners who do not understand their obligations and scrupulously inspect the documents submitted along with payment applications each month take a huge risk.
Yes, it is important to get the basic paperwork, the lien waivers and sworn statements. I think most owners and developers know that.
But what few understand is that it is the content of those documents that really matters.
It is not enough to just collect the lien waiver from each subcontractor and general contractor. Project owners and developers need to inspect each document and ensure that the content complies with Illinois law, and also matches up with the facts on the ground.
If owners and developers do not know what they are looking for in the sworn statements submitted by the general contractor and its subcontractors, then they won’t know when the law imposes an obligation upon them to act.
They will not know the red lights from the green lights.
This means potential bad outcomes for owners and developers in mechanics lien litigation.
Real estate developers and project owners should not over-rely on title insurer review, unless it was hired to look out for the developer or the owner, rather than for their lenders.
The Owner’s Monthly Sworn Statement Submitted in Support of the Payment Application
It is common each month for the lender and title insurer to require the project owner or developer to submit its own sworn statement supporting the contractor’s payment application.
Often, it is a mirror image of the contractor’s sworn statement, as the title insurer wants the content to align. If it does not match, the title insurer may put the brakes on payment.
Where owners and developers can get into trouble is if they merely rubber-stamp the content of the contractor’s sworn statement in their own sworn statement without critically thinking about that content.
Because again, it is the content of these documents that really matters.
And the title insurer gets to rely on the information submitted each month by the owner; particularly if the owner signs the document under oath and under a notary’s stamp.
This reliance, in many respects, is a one-way street.
So if a surprise mechanics lien is recorded, the project owner or developer is much less likely to be able to successfully say – “Hey-title-insurer, what-gives? I-relied-on-you” – than the title insurer is going to be able to argue that it paid in reliance on the sworn documents that the owner itself submitted.
The Bottom Line
Real estate developers and project owners should not over-rely on title insurer review.
Rather, you should, first, understand your obligations under the Illinois Mechanics Lien Act.
Second, realize there might not be perfect alignment between your interests and that of your lender and title insurer.
And third, figure out a practical and reasonable way to comply with your obligations under the Lien Act.
Because with mechanics lien disputes, generally, whoever follows the Lien Act more closely wins.
So if the developer is a large and sophisticated outfit, perhaps it has the in-house ability to adequately review the payment applications and supporting sworn statements and lien waivers each month.
But if the developer is smaller or newer in the development game, or if the property owner is only an occasional consumer of design and construction services, in those circumstances, they may not have the in-house ability to conduct that review.
In that case, they should consider outsourcing that review.
Now there are several options beside construction attorneys to correctly execute that review each month.
And to be honest, there are probably less expensive options than using attorneys for that review.
But an attorney who specializes in design and construction can help guide the way for project owners and real estate developers through the complexities and risks of mechanics liens in the monthly payment application process.
Check out our other resources for real estate developers and property owners!
This publication is prepared for the general information of friends of Baker Law Group LLC in Illinois. It is not legal advice for you, or legal advice regarding any specific matter. Jeremy S. Baker is licensed to practice law only in Illinois. Under rules applicable to the professional conduct of attorneys in various jurisdictions, it may be considered attorney advertising material. Prior results do not guarantee a similar outcome.