Virginia recently enacted and signed into law Senate Bill 891, effective on July 1, 2015, which renders null and void construction contract clauses containing pre-work waivers or limitations on the ability of subcontractors, lower-tier subcontractors, and material suppliers to file or enforce mechanic’s liens, bond claim rights, and claims for demonstrated additional costs. With this new law, Virginia joins the majority of states that have similar laws in place barring prospective lien waivers in construction contracts. The effects of the new law promise to impact financial risk shifting between owners (and their financiers), general contractors, subcontractors, and suppliers. Notably, general contractors are currently excluded from the new law’s protections. Consequently, the new law as written may have the potential to transfer significantly more financial risk onto general contractors.
New Statutory Language
The new law amends Titles 11 and 43 of the Virginia Code, which address Contracts and Mechanic’s Liens, respectively. Section 43-3 adds new language to subsection (C) as presented below (italicized):
C. Any right to file or enforce any mechanic’s lien granted hereunder may be waived in whole or in part at any time by any person entitled to such lien, except that a subcontractor, lower-tier subcontractor, or material supplier may not waive or diminish his lien rights in a contract in advance of furnishing any labor, service, or materials. A provision that waives or diminishes a subcontractor’s, lower-tier subcontractor’s, or material supplier’s lien rights in a contract executed prior to providing any labor, services, or materials is null and void. . . .
Similarly, almost identical language appears in the new Virginia Code section 11-4.1:1, which applies to payment bond claims and “the right to assert claims for demonstrated additional costs.” The statutes expressly mandate that subcontractors and suppliers cannot contractually waive or diminish these rights, and arguably also apply to any third-party waiving such rights on their behalf, which has been barred in other states.
Owners and general contractors should consider the possibility that the language of the new law may be applied beyond provisions expressly addressing liens and bond claim waivers. Key to an understanding of how broadly the new statutes will be applied in the future is the interpretation of the phrase “waive or diminish” in both statutes and what falls into the category of “claims for demonstrated additional costs” under § 11-4.1:1. A broad interpretation could potentially result in limitations on other sometimes controversial clauses between general contractors and their subcontractors and suppliers.
Financial Risk Shifting Considerations
A sizeable shift in how general contractors and subcontractors in Virginia bear the financial risk on construction projects could occur in subcontracts and change orders, or other subcontract amendments, dated on or after the effective date of July 1, 2015 (Virginia has generally disfavored retroactive interpretation of new laws absent express legislative intent). Of significant concern for general contractors is that the new law creates a situation where owners on Virginia construction projects can contractually require general contractors to waive their mechanic’s lien rights and claims for additional costs, but general contractors are proscribed from passing similar provisions onto subcontractors and suppliers to mitigate the risk of owner non-payment.
An early question might be the continued validity of changes clauses setting out procedures for making additional cost claims, such as requiring a subcontractor to receive express, written authorization from the general contractor or limiting the number of days a subcontractor has to submit a change order request after costs are incurred. Such procedures help avert disputes and litigation over subsequent disagreements for allegedly extra work; however, they could possibly now run afoul of the “waive or diminish” language in the new law.
Subordination clauses altering the priority of liens also could potentially be challenged, more so in Virginia where mechanic’s liens are inchoate. A comparison with Virginia’s new statutory language might be drawn with California’s anti-lien waiver statute, which similarly states that lien rights may not be “waive[d], affect[ed], or impair[ed].” A recent appellate decision in California suggests the possibility that its anti-lien waiver law could support an interpretation that subordination of lien rights violates its policy. See Moorefield Constr., Inc. v. Intervest-Mortgage Inv. Co., 178 Cal. Rptr. 3d 709, 715-20 (Cal. Ct. App. 2014) (interpreting a prior version of the statute to protect general contractors). The use of “diminish” in Virginia’s new law could be interpreted by its courts to encompass subordination of liens to other legal interests in the project property, such as deeds of trust and construction lender advances. This would remove another negotiating pawn for general contractors in crafting both their prime and subcontracts. That said, there is no clear, current trend among other states labeling subordination clauses akin to lien waivers. This is an area that construction professionals will have to review for future development in Virginia and elsewhere. A declination by Virginia courts to extend the new law to subordination clauses could alternatively result in a muted effect for the application of “diminish.”
“Pay-if-paid” clauses (conditioning subcontractor payment on general contractor’s receipt of payment) could become another casualty of the new law, which would mark a shift in prior Virginia policy of accepting the validity of such clauses. Again, such provisions could be challenged based on the “diminish” language in the new law, based on an argument that conditional payment affects the ability to file a valid lien or make a valid bond claim. Such arguments have been successful in California and New York, and several states ban such clauses. Yet, if such an interpretation were adopted by Virginia courts due to the new law, general contractors might delay (but not avoid) the financial consequences of nonpayment from the owner through the substitution of “pay-when-paid” clauses (pertaining to timing of payment rather than condition), which some states have found do not violate anti-lien waiver laws.
The implication for pay-if-paid clauses could be significant for general contractors and owners (and their lenders) on Virginia construction projects. The latter will likely become subject to greater lien exposure, with such inchoate liens difficult to invalidate through foreclosure, the sale of the property, or bankruptcy. The owner could, however, contractually require the general contractor to bond off such a lien while also possibly enforcing the general contractor’s agreement to waive its own lien rights. Still too, owners may assert a defense of payment under Virginia’s mechanic’s lien law, leaving the subcontractor only with remedies against the general contractor. Va. Code. § 43.7.
Moreover, a Virginia subcontractor or supplier is under no obligation to file and enforce a mechanic’s lien against the owner over a bond claim against the general contractor. If a defense of payment may be raised by the owner or the mechanic’s lien would have unfavorable priority against the owner’s property, the unpaid subcontractor or supplier may prefer to make a claim on the general contractor’s payment bond. In such a case, the general contractor would likely become liable to indemnify the surety for the subcontractor’s claim on the payment bond with limited recourse against the owner if it has not been paid and has no lien rights. One way general contractors might consider offsetting the risk of bond claim losses from lower-tier subcontractors and suppliers is by more frequently requiring subcontractors to furnish their own bonds. Additionally, general contractors might consider including anti-assignment provisions of lien rights in their subcontracts to reduce chances of such claims being enforced by third-parties.
Despite its express focus on pre-work waivers, Virginia’s new law may also limit the ability of general contractors to include progress payment waiver templates as part of the subcontract. If such forms waive retainage for the progress payment period this arguably might violate the new law’s command not to prospectively “diminish” rights. On the other hand, separate lien waivers agreed to after the execution of the subcontract and partial performance of some work are presumably not addressed by the new law. Developing waiver forms during the project performance might require additional negotiation and uncertainty about whether the owner and general contractor will receive a conditional or unconditional waiver. Furthermore, a lien waiver form created after the subcontract execution and during the project performance might still potentially violate the new law’s prohibition if it waives the subcontractor’s ability to file any subsequent liens for any remaining portion of the work in exchange for a progress payment. Despite these possibilities, it is worth noting that the language of lien waivers in general remains unregulated in Virginia. As such, some room remains for general contractors in negotiating these forms to share ongoing financial risks on a project.
The new statutory language addressing pre-work waivers of mechanic’s liens, payment bond claim rights, and claims for additional costs for subcontractors, lower-tier subcontractors, and suppliers must be kept in mind for owners and general contractors entering new contracts. The new statutory language has potential implications for financial risk shifting provisions in Virginia construction contracts. Owners, general contractors, subcontractors, and suppliers should work closely with legal counsel to evaluate the breadth of their financial risk when entering into new construction projects and to determine whether any new developments in the law could affect their contract rights.