When analyzing liens related to tenant improvements performed pursuant to a contract between a tenant and contractor, we are frequently asked whether the lien attaches just to the tenant’s leasehold interest (i.e., the value of the lease) or whether the lien can also attach to the landlord’s fee interest in the real estate where the leased premises are located. Landlords want protection from liens, whereas contractors want lien rights against both the leasehold interest and the landlord’s fee interest in the property because liening the fee interest will likely place additional pressure on the tenant to resolve the lien and because the fee interest typically provides greater security. Washington’s lien statute and several cases provide guidance.
Under RCW 60.04.010, “any person furnishing labor … for the improvement of real property shall have a lien upon the improvement for the contract price of labor, professional services, materials, or equipment furnished at the instance of the owner, or the agent or construction agent of the owner.”
In the landlord/tenant context, whether a lien can attach to the landlord’s fee interest typically turns on whether the tenant is the landlord’s agent. An agency relationship arises if the lease requires the lessee to improve the property. Hewson Const., Inc. v. Reintree Corp., 101 Wn.2d 819, 823, 685 P.2d 1062 (1984). “The test is whether the lessee, under the terms of the contract, has a privilege merely, or is obligated, to construct improvements.” Miles v. Bunn, 173 Wash. 303, 305, 22 P.2d 985 (1933). In discussing the underlying policy, the Washington Supreme Court has noted that:
though hardship must sometimes occur to the owner of land by lien laws, he at least receives and keeps the improvements, and that he is the better able of the two classes, by indemnity beforehand, to protect himself entirely.
Bunn v. Bates, 31 Wn.2d 315, 319, 196 P.2d 741 (1948).
For example, in Markley v. General Fire Equipment Co., Markley entered into a lease agreement with Bridge Receiving Homes in which the tenant agreed “to make all the repairs required by the building, fire or wire codes….” 17 Wn. App. 480, 481, 563 P.2d 1316 (1977). As a result of an inspection by the fire marshal, Bridge Receiving Homes contracted with General Fire Equipment Co. to install certain fire safety equipment. Id. at 481-82. After it became apparent that Bridge Receiving Homes would be unable to pay its bill, General Fire Equipment Co. recorded a lien. Id. at 482. In General Fire Equipment Co.’s foreclosure suit, the trial court entered judgment against the landlord, Markley. Id. at 483. On appeal, Division III of the Washington Court of Appeals affirmed, finding that:
where a lessee is required by the terms of a lease to construct a building according to certain specifications on land owned by the lessor, which is to be paid by crediting the lessee’s rental against the cost of the building, the lessor is in effect erecting the building through the lessee, as agent, and both interests were subject to a mechanics’ lien.
Id. at 484. Thus, the Court held that the landlord Markley’s interest in the property was subject to the lien because the lease required Bridge Receiving Homes to make the improvements performed by General Fire Equipment Co.
Based on this precedent, the issue of whether a lien can attach to just the leasehold interest or also to the landlord’s fee interest in the real estate will depend on the language of the lease. If lease language requires a tenant to perform tenant improvements and provides that the landlord will pay for some or all of the lease improvements, this will potentially establish an agency relationship that supports the argument that the contractor’s lien can attach to both the leasehold interest of the tenant and the fee interest of the landlord.
- Contractors performing tenant improvements should obtain a copy of the lease or at least provisions related to tenant improvements before commencing work to evaluate potential remedies for nonpayment. If lien rights will be limited to the leasehold interest, an evaluation of the tenant’s financial wherewithal to pay for the work is imperative.
- Landlords should seek advice on how to limit exposure to liens against their fee interest. While risk mitigation measures depend on transaction specific facts, potential ways to mitigate this risk is eliminating lease language that requires the tenant to perform the tenant improvements. The landlord can require a tenant to provide a payment bond covering the value of the improvements so that contractors can seek payment from the bond. And a landlord can ensure that a tenant has adequate funding for the tenant improvements in advance of lease execution.
- A&C lawyers can assist both contractors and landlords with evaluation this issue to mitigate risk in advance of commencement of tenant improvement work.