Alert: Notices of Non-Responsibility Do Not Necessarily Afford As Much Protection As Owners and Contractors Think

February 28, 2003

California landowners customarily rely on Notices of Non-Responsibility to protect their property interests from mechanics' liens stemming from tenant improvements. However, a recent California case serves as a powerful reminder to landowners, contractors and suppliers that these notices do not always effectively preclude mechanics' lien claims that can lead to foreclosure on the landowner's property.

In Howard S. Wright Construction Co. v. Superior Court (Feb. 14, 2003) ("Wright Construction"), the court held that landowners who timely and properly post and record Notices of Non-Responsibility are not protected from mechanics' liens when they are a "participating owner." This principle - commonly referred to as the Participating Owner Doctrine - is not new in California. There are very few reported cases dealing with the Participating Owner Doctrine, but California courts long ago established a litmus test for applying it: Is the tenant required by the lease to make improvements? If so, the landowner is a "participating owner" and remains liable to mechanics' lien claimants despite having posted and recorded a Notice of Non-Responsibility.

Wright Construction refines the scope of protections afforded by Notices of Non-Responsibility and highlights the factors evaluated in determining whether the Participating Owner Doctrine applies. Although no single factor is determinative, the court in Wright Construction noted that the presence of one or more of the following factors could lead to a finding that the landowner is a "participating owner:" (1) whether the lease contemplated renovation; (2) whether the landowner controlled tenant's renovations under the lease; (3) whether the lease required the landowner and tenant to essentially act as joint venturers in the renovations; and (4) whether the renovations benefit the landowner's interest in the leased property.

In Wright Construction, the court evaluated these factors and concluded that the landowner's Notice of Non-Responsibility failed to shield it from $2.4 million in lien claims. In this case, the landowner leased a warehouse to a startup telecommunications company and prohibited the tenant from using the warehouse for anything but telecommunications purposes. The tenant started its renovations, but went bankrupt before they were completed.

In analyzing the effectiveness of the landowner's Notice of Non-Responsibility, the Wright Construction court paid particular attention to the first factor - whether the lease contemplated the tenant's renovation. The court focused on the lease's use requirement, and noted the tenant had no practical option but to renovate the leased property. Additionally, the court found that the landowner controlled the tenant's renovations because the lease required the landowner's approval of the alterations, and further required that the landowner be paid an "administrative fee" for "overseeing" the alterations. Finally, the court determined that the renovations significantly benefited the landowner's interest in the leased property because many of the improvements were permanent fixtures that increased the property's value. Consequently, the landowner's Notice of Non-Responsibility failed to protect it from the mechanics' lien claims.

Lessons Learned
Most standard leases include at least some (if not many) provisions that can lead to a "participating owner" determination. Landowners can strip all such provisions from their leases, but the importance of these provisions generally outweighs the risk of mechanics' liens. Accordingly, landowners, contractors and suppliers have several issues to consider.

Landowner Considerations
There is no single lease provision that if included or excluded will guarantee the protections afforded by Notices of Non-Responsibility, but some of the issues that landowners should evaluate include:

• Whether to require tenant improvements.
• Whether to limit tenant uses to the point that improvements are required.
• Whether landowner is to financially contribute to tenant renovations through payments or rent reductions.
• Whether to base rents on the tenant's revenue.
• Whether to require payment bonds naming the landowner as an obligee.

Contractor & Supplier Considerations
Some of the issues that contractors and suppliers should evaluate include:

• Whether to provide a Preliminary 20-Day Notice when the landowner posts a Notice of Non-Responsibility.
• Whether to name the landowner as a defendant in a lien foreclosure action.

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For more information, please contact your Farella Braun + Martel attorney or Scott Douglass at sdouglass@fbm.com or 415-954-4498.

This Construction Law Update is published as a service to our clients and friends. It should be viewed only as an overview of the law, and not as a substitute for legal consultation.