Uncovering the Hidden Liens That Can Affect Your Deal
ComplianceAugust 22, 2020

Uncovering the hidden liens that can affect your deal

Hidden liens can delay or terminate a transaction and should be carefully considered during the due diligence process. Therefore, it is critical that legal counsel adopt a vigorous search methodology to uncover certain lien types that are pertinent to the deal.

Typically, lien searches begin at the Secretary of State’s office before moving to the local and county level, and then onto the discovery phase of potentially hidden liens. It’s an extensive process but a necessary one. Unexpected liens can jeopardize a deal, impact the price of a company, or cause post-closure issues. Here are some examples of hidden liens and some tips for improving your search strategy.

Mechanic liens

A mechanic lien is a guarantee of payment to builders, contractors, construction firms, and related entities that build or repair structures. These liens extend to suppliers of materials as well as subcontractors. All jurisdictions have some form of mechanic or materialmen’s lien.

For example, a property owner may hire a contractor to oversee a project. The contractor then hires a subcontractor to assist with the job. If the contractor fails to pay the subcontractor, the latter can file a mechanics lien against the property owners – even if they have never met or entered into any form of agreement.

As you embark on a mechanic lien search, there are several nuances to consider.

Did you know?

Mechanic lien requirements are not uniform and vary by state in areas such as preliminary notice, cost, duration, and the extent of the notice. Two things are consistent: mechanic liens are filed in the county where the property is located, and some form of notice must be issued to the property owner (although the notice requirement varies).

The intent of the filing is to create a window of time in which the parties can work out a deal. If none is reached, then the lienholder should file a lawsuit to maintain claim. If no lawsuit is pursued, then liens should come off the books, although laws and procedures can vary.

The general rule for all liens, even mechanic liens, is “first in time/first in right”. Yet some mechanic liens laws permit a filing to relate back to the first contract to the contractor/owner and that agreement could pre-date the mortgage.

Some states have super priority liens, a limited but powerful tool where a mechanic lien can “take down” a prior claim. For example, Illinois has a special rule regarding "enhanced value” section 16 MLAct, which gives mechanic liens legal standing even if they are filed post-mortgage if they have enhanced the value of the property.

Mechanic liens do have a shelf life, and, again, this can vary by jurisdiction. In California, a mechanic lien is good for 90-days, while in Florida they are good for a full year after filing.

Deutsche Bank Trust Co. Americas v. First River Energy LLC

One of the primary goals of the UCC is to promote certainty and predictability in commercial transactions. But the adoption of nonstandard UCC provisions, like those in Texas, or the imposition of certain state law statutory rights, like those in Oklahoma, can introduce chaos to UCC’s standard order and reliability. Deutsche Bank Trust Co. Americas v. First River Energy LLC illustrates the problems that can arise when there are conflicting laws and liens from multiple parties.

Deutsche Bank AG New York Branch, along with other banks and financial institutions, made a loan to First River Energy, a Delaware LLC. First River Energy then engaged with numerous upstream producers of oil and gas in Texas and Oklahoma.

In November and December 2017, First River was unable to fulfill its payment obligations according to the terms of the credit agreement with Deutsche Bank. First River also failed to pay its upstream vendors for oil and gas purchases in December. The company filed for bankruptcy in January 2018.

Deutsche Bank had a legal basis to claim a first-priority security interest in the borrower’s assets. The Texas producers also claimed priority due to their state’s version of the UCC that governs perfection and priority of liens for oil produced in Texas. The Oklahoma producers claimed priority due to the Oklahoma Lien Act, which states that "the interest owner's oil and gas lien created by the Lien Act is not a UCC Article 9 security interest but rather arises as part of a real estate interest of the interest owner in the materials."*

The facts suggested enough uncertainty to lead to litigation because of the question regarding the true character of an oil and gas interest. Is it real property or personal property?

*Deutsche Bank Trust Co. Americas, Agent v. First River Energy LLC (In re First River Energy LLC), Adv. Case No. 18-05015-CAG, 2019 Bankr. LEXIS 749, at *41 (quoting Okla. Stat. Ann. tit. 52 § 549.3(A), cmt. a).

Judgment liens

A judgment lien is a type of non-consensual lien (a lien that attaches to a property without the owner’s agreement). It’s created when someone wins a lawsuit against the property owner and then records the judgment against an asset such as a house, land, bank account, or other personal assets.

Note: Non-consensual liens do not follow UCC rules regarding “organic public record” for debtor name. Therefore, trade names, old names, and even nicknames can be used, and liens are enforceable.

Almost any legal scenario can be converted into a judgment lien. Some examples include the following:

  • Unsecured creditor (credit card) pursues a judgment
  • Tort (slip and fall, sues and wins)
  • Former employee sues and wins
  • Disputes between owners

Did you know?

Depending on the jurisdiction, most judgments liens can attach to after-acquired property. Judgment liens have a shelf life (typically 7-10 years). However, unlike a mechanic lien, a judgment lien can be continued indefinitely in most states—like a UCC filing.

While most prior-filed UCC 1 will prevail over judgments, some ambiguity exists in “factoring” cases where a secured party gets a judgment notice from a third party. For example, California code has a 45-day notice rule.

ERISA liens

Enacted by the Employee Retirement Income Security Act of 1974, ERISA is a federal law that governs retirement, health, life, and disability benefits for Americans. It was created to protect the employee and their funds that were contributed to covered plans via payroll deductions. ERISA sets minimum standards for most voluntarily established pension and health plans in the private industry to provide protection for individuals in these plans.

If an employee is injured due to the negligence of another and that employee’s medical expenses are paid by a health benefits plan governed by ERISA, the employer can recover those expenses.

In resolving a personal injury claim, there may be a number of liens of varying types that attach to the settlement proceeds and which must be properly dealt with before ultimately completing the case and disbursing the proceeds to the client and the attorney.

Did you know?

There are two types of ERISA plans that can impact ERISA liens:

  • Self-funded plans – Legal counsel must follow ERISA-federal code exclusively.
  • Insured third-party plans – Due to insurance, state law comes into play so legal counsel must look to state rules regarding liens.

CERCLA/EPA

The Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), commonly known as Superfund, was enacted by Congress in 1980. This gave the Environmental Protection Agency (EPA) broad powers to identify responsible parties regarding hazardous waste, to impose liability and to ensure compliance with cleanup. In 2002, Brownfield Amendments gave states more direct responsibility for cleaning up sites — and, of course, having liens.

Consequently, CERCLA has created several types of liens:

  • Primary CERCLA Lien – Can be imposed on owners where hazardous material was disposed or possessed regardless of FAULT or involvement.
  • Maritime Lien – If release or threatened release of hazardous materials is from a vessel.
  • Windfall Lien – If an owner has benefited from the cleanup and there exists unrecovered response costs and those costs enhanced the Fair Market Value of the property.

To establish its priority among other secured parties and creditors, the EPA must file notice of the lien in the appropriate office within the state in which the real property subject to the lien is located (or county or other governmental subdivision), as designated by state law. These claims can come before any previously filed UCC, mortgage, judgement and “other federal liens”.

It’s important to note that not every state has the same type of rules regarding super priority for the cleanup.

Did you know?

Recent developments should also be considered. For example, in April 2020, the U.S. Supreme Court determined that CERCLA does not preclude Montana residents from bringing state common law claims to recover the cost of property cleanup beyond the EPA-approved cleanup plan. The Court also ruled that only the EPA has the authority to approve changes to its cleanup plans. Landowners are potentially responsible parties that must obtain EPA approval of remedial work.

Agricultural liens

The definition and requirements of an agricultural lien vary by state but broadly speaking it protects the seller of agricultural equipment by giving them a lien on crops grown with the equipment or rent on real property leased by a debtor in connection with their farming operation.

Did you know?

An agricultural lien is created by the existence of certain conditions specified by the statute and is mainly non-possessory, hence a filing is needed.

Secured parties may need to satisfy additional statutory requirements such as issuing some type of notice (depending on the state’s definition of “notice”). These liens also have a shelf-life.

It’s also important to know that Article 9 rules do not apply to an agricultural lien. Like PMSI filing, it can jump to the priority line.

To perfect a security interest in goods, the UCC typically requires filing where the debtor is located. However, an agricultural lien is perfected by filing in the state in which the collateral is located, not the proceeds of the collateral.

To add to the confusion, some states permit the use of similar filing documents (basically a UCC 1) so it can be interpreted incorrectly.

Tips for discovering hidden liens

As you embark on the lien discovery phase of the due diligence process, take account of the following:

  • Consider the transaction – Hidden liens may not always be intuitive. Review transaction details accordingly and consider all available types of liens and refine your search strategy.
  • Collect the data – The more information you have, the more questions you can ask. Gather important information such as prior names of debtor/parties, IRS documents, assets, addresses, etc. Confirm the data is reliable.
  • Ask the questions – What is the company history? Who are the players? What is their litigation history? What else was communicated? What are the open and closed litigation cases?
  • Determine roles – Who is doing what? What is the title company doing? What has been communicated?
  • Do your research – Consider all applicable state laws. Where should liens be held? Were the liens perfected? How long are they in effect? Run broad lien searches.

Failure to understand search logic may result in missing hidden liens. It’s important that you understand the databases searched and how their logic works.

Daniel W. Lias
Transactional Business Consultant

Daniel W. Lias is the Transactional Business Consultant in the Chicago office of CT covering the Midwest.   He works primarily with area law firms in terms of their due diligence searches and filings.

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