Protecting leased property against construction liens

Landlords do not want their ownership interest to be subject to construction liens resulting from improvements made by their tenants. However, unless certain steps are taken, a Florida landlord's property WILL be subject to liens, even if they are unaware that the tenant has contracted for improvements. Chapter 713.10(2), Florida Statutes provides two options for the landlord to protect against liens on his interest:

-->First, the landlord may include a provision in the lease expressly prohibiting liens for tenant improvements and record the lease (or a short form of the lease) in the public records to put the world on notice;

-->Second, the landlord (if he leases to multiple tenants) may include an express prohibition of liens for tenant improvements in all of his leases and records a notice in the public records which contains enumerated information and states the specific language in the leases.

A landlord must be very careful when using the second option. A court recently reminded landlords how careful they must be to meet the statutory requirement. (Everglades Elec. Supply, Inc. v. Paraiso Granite, LLC, 28 So.3d 235 (Fla.App. 4 Dist.,2010). In that case, the landlord had included language limiting construction lien liability in all of its leases. However, in one of the leases, the landlord had used slightly different language limiting liability. The court held that since the language was not the same in all of its leases, then the notice which was recorded was defective because it did not include "The specific language contained in the various leases prohibiting such liability." Landlords should take note and consult an attorney to be sure that the notices they record comply with the detailed and technical construction lien law.

Can debts arising from misapplied construction funds be discharged in bankruptcy?

Recently, a case out of the Federal Sixth Circuit Court of Appeals made headlines, holding that a contractor in Michigan receiving funds from the owner on a job could not use bankruptcy to discharge its debts to a subcontractor (or probably a laborer or material supplier) to whom the contractor should have passed along the funds. Patel v. Floorcovering Services, Inc. This holding extended not only to the contractor (a corporation) but to the licensed contractor who guaranteed its debts. The cardinal bankruptcy concept is that the debtor receives a fresh start, with all debts being paid or wiped away by the bankruptcy process. The narrow exceptions to this "discharge" of debts are enumerated in Section 523 of the bankruptcy code. They include certain types of debts (such as student loans, to the chagrin of certain of my law school classmates) and debts resulting from wrongdoing such as "fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." In Michigan, at least, the misapplication of construction funds received from the owner falls into this category.

A trustee acts in a fiduciary capacity. Under Michigan law, funds paid by an owner for the benefit of subs, laborers or material supplieres are considered trust funds, and the contractor or subcontractor is considered the trustee of the funds. Because the basic rule is that trustees act in a fiduciary capacity, the debts of the contractor (or sub) to his subs, laborers and material suppliers cannot be removed by bankruptcy.

As mentioned in a previous post, bankruptcy courts must make decisions involving both federal and state law. Obviously, the question facing Florida construction professionals is whether Florida law would intersect with federal law in the same way such that Florida contractors would not be able to discharge debts in bankruptcy resulting from the misapplication of funds. In contrast to the recent ruling interpreting Michigan law, when deciding In re Gropp, 153 B.R. 350(Bkrtcy.M.D.Fla.1993), a Florida bankruptcy court reiterated its position that even though Florida law makes misapplication of construction funds a crime, it does not create a "fiduciary" duty such that the debt would be immune to bankruptcy discharge. Although Florida's Section 713.345 (outlawing misapplication of funds) seems to have much in common with Michigan's law at 570.151-153, MCL (outlawing misapplication of funds), the Michigan law can be distinguished because it specifically states that money paid under a construction contract to a contractor (or sub) is considered a trust fund and the contractor or sub receiving the fund "shall be considered the trustee of all funds so paid to him for building construction purposes."

Despite the subtle differences in various state statutes, the Sixth Circuit will have some persuasive authority nationwide. It will be interesting to see if attorneys in jurisdictions outside Michigan (including Florida) attempt to use the Patel v. Floorcovering Services, Inc. decision to expand the scope of debts resulting from wrongdoing that cannot be wiped clean by bankruptcy.

Loss of Construction Jobs in Florida

The Associated General Contractors (AGC) of America has published an analysis of federal construction employment figures and determined that employment has declined in 276 of 337 metropolitan areas in the year ending July, 2010. According to the September 1, 2010 issue of the Orlando Business Journal, this decline was felt at the rate of 8% in the Orlando metro area and 7% throughout the areas analyzed within Florida.