Chapter Seven: The Stop Notice

1. Introduction.

   As explained in the previous chapters, a person providing labor, professional services, materials, or equipment for the improvement of private real property is protected against nonpayment with a construction lien encumbering the improvement and (sometimes) the underlying real estate.  Construction liens are available in all 50 states.  Some states provide additional protections for lien claimants.  In Washington, the chief of these additional protections is the stop notice remedy.

   The stop notice remedy is intended to protect persons providing lienable work in situations where a construction lien may be ineffective.  For example, if a developer borrows construction funds and the lender records a mortgage before any work begins, the lender’s interest in the project property will be before that of any lien claimant.  If the lender’s interest approaches the market value of the property, there will be no equity left for a lien claimant.

   To address this problem, Washington law permits a potential lien claimant to send a notice to the owner’s construction lender directing the lender to withhold stated amounts from future draws by the owner.[1]  Upon receipt of the notice, a construction lender must either take steps to protect the lien claimant’s interest or else risk having its security subordinated to the construction lien.  Similar remedies are available in other states.  The common term for this type of remedy is a “stop notice.”  That term will be used here.

   Because it potentially interrupts the flow of loan proceeds, a stop notice gives the owner an incentive to deal with an unpaid contractor or subcontractor.  A stop notice does not (except as noted below) change the priority of the claimant’s lien.

   The following sections will examine the stop notice remedy from the points of view of those most directly involved.[2]   In particular:

   • Section 2:  Stop Notices from the Lien Claimant’s Perspective.
   • Section 3:  Stop Notices from the Lender’s Perspective.
   • Section 4:  Stop Notices from the Owner’s Perspective.
2. Stop Notices from the Lien Claimant’s Perspective.

   For a stop notice to be effective, several preconditions must be met.  First, the person submitting the stop notice must be a “potential lien claimant.”  This term is defined in RCW 60.04.011(11) to mean a person “entitled to assert lien rights under this chapter who has otherwise complied with the provisions of this chapter” and who has also complied with applicable licensing requirements.  So, the stop notice is available only to a person who (at the time the notice is given) has performed lienable work on private property at the request of the property owner or his construction agent.

   The phrase “potential lien claimant” indicates that a stop notice may be issued at an early stage of a project before the issuer has become an actual (as opposed to a potential) lien claimant.  The statute does not require a person pursuing a stop notice to also pursue a construction lien.  However, a stop notice and a construction lien certainly may be pursued together[3] and there is good reason to do so:  as explained below, a claimant may lose valuable rights under the stop notice statute if she fails to perfect her construction lien.

   A second requirement for a stop notice is a lender providing “interim or construction financing.”  This term means funds secured by a mortgage or other encumbrance on real property to finance an improvement to that property.[4]  Funds loaned to acquire the property, to pay for insurance or taxes, or to acquire non-lienable personal property do not count as interim or construction financing for purposes of the stop notice statute.  In some cases, only part of a loan may qualify as interim or construction financing.  The evident intent is that the interim or construction financing must fund the improvement that the issuer of the stop notice is working on, though this is not stated expressly.

   The stop notice remedy is not available if the borrower has obtained a payment bond of at least 50 percent of the amount of construction financing.  The idea is presumably that the bond security makes a stop notice unnecessary.  However, payment bonds come in various forms.  A bond may or may not secure payments to all potential lien claimants, and it may contain notice requirements or other conditions precedent that complicate recovery.  Presumably, the legislature intended to bar stop notices only in cases where the potential lien claimant has reasonable access to the protection of a bond, though this is not stated expressly.

   Another requirement for issuing a stop notice is that the potential lien claimant must have performed work for which timely payment has not been made.  The statute says that the notice may be issued “within thirty-five days of the date required for payment of the contract, invoice, employee benefit plan agreement, or purchase order.”[5]  Construction contracts and purchase orders commonly state that payment is due within a certain number of days of the invoice.  If no payment date is specified by the agreement, there is the authority that the notice deadline should be measured from the date payment was requested and refused.[6]  If the last day of this period falls on a Saturday, Sunday, or legal holiday, the period for sending the notice will be extended to the next day that is not one of those days.[7]  There is a potential trap for the unwary here.  If a project has cash-flow problems, a potential lien claimant may acquiesce in late payments.  However, if a claimant allows 35 days to pass before issuing a stop notice, she may discover that her notice is late because the deadline is measured from the date payment was “required” under her contract, not the date to which she had informally acquiesced.

   The statute says that the notice should not be sent until payment is five days overdue; this gives a 30-day window for the notice.  If no payment date is specified by the agreement, it would probably be safest to wait five days after a refusal of payment before submitting the stop notice.

   The statute contains detailed directions regarding the content of the notice, the persons to whom it should be delivered, and the permitted means of delivery.  These directions should be consulted when preparing a stop notice.  One requirement is that the notice be delivered to the lender’s “office administering the interim or construction financing.”  The location of this office should be stated on a notice posted by the prime contractor under RCW 60.04.230(1) or on the building permit posted under RCW 19.27.095.[8]  But these posting requirements apply only to projects costing more than $5,000.  On small projects, a claimant may need to make inquiries.

   RCW 60.04.221(1) indicates that the stop notice may include a statement of “the sums due and to become due.”  The statutory form of notice, however, lists only the “amount owing” and RCW 60.04.221(5) says that the lender should withhold only “the amount claimed to be due.”  It appears that stating amounts “to become due” will not be effective.[9]  If a claimant wishes to have ongoing protection, she should submit a stop notice each time an invoice goes unpaid for more than five days.[10]

3. Stop Notices from the Lender’s Perspective.

   Upon receipt of a stop notice, the lender is directed to “withhold from the next and subsequent draws the amount claimed to be due” or else obtain a payment bond for the benefit of the claimant.[11]  Although the statute seems to limit the lender’s options to two, the lender has more options than these.  The lender must choose its response promptly, even before knowing whether the information in the stop notice is accurate.[12]

   If there is a payment bond in place for (at least) 50 percent of the interim or construction financing amount, claimants protected by the bond have no stop notice rights.  In that case, the lender need take no action in response to a stop notice.  If all of the loaned funds have been disbursed, there are no “subsequent draws” from which to withhold money, so the stop notice has no effect.  Again, the lender need not respond to the stop notice.

   Upon receipt of a stop notice, the lender may withhold funds from the “next and subsequent draws” up to the amount stated in the stop notice.  “Draw” means a disbursement of interim or construction financing.[13]  So for example, if the borrower is entitled to a draw of $12,000 but a stop notice is submitted for $5,000, the lender must withhold $5,000 and may disburse no more than $7,000.  If the draw is $12,000 but a stop notice is submitted for $20,000, the lender must withhold the entire draw and then continue to withhold from the next draw(s) until a total of $20,000 has been withheld.  Making an accounting entry is not sufficient.[14]  Paying subcontractors and suppliers directly is also not permitted.[15]  The money withheld must be retained until there is a written agreement between the claimant, the owner, and the prime contractor, or until receipt of a court order.[16]

   Another option for the lender is to obtain a special payment bond for the benefit of the stop notice claimant.  The bond must be in (at least) the amount claimed.  The statute suggests that the bond must come “from the prime contractor or borrower,” but presumably any interested party could provide the bond.

   Another option for the lender is to continue disbursing funds to the borrower.  In that case, the lender’s security will be “subordinated to the lien of the potential lien claimant to the extent of the interim or construction financing wrongfully disbursed.”[17]  So for example, if after receipt of a stop notice for $10,000, the lender disburses $25,000 from the loan, the amount wrongfully disbursed is $10,000.  In the same scenario, if the lender disburses $7,500 from the loan, the amount wrongfully disbursed is $7,500.

   Of course, the lender’s interest can be “subordinated to the lien” only if the stop notice claimant also perfects a construction lien.  It would be wise for her to do so, just to keep the subordination remedy available.  Even if the lender initially withholds money as requested in the stop notice, the claimant should continue to perfect her construction lien because, if she fails to do so, the lender could choose to disburse the withheld funds to the borrower.  For this reason, the lender can expect the issuer of a stop notice to take the necessary steps to perfect her construction lien.

   The final option for the lender is to make no further disbursements and foreclose on its mortgage or other security.[18]  This option is open even if the lender has initially withheld funds under a stop notice.  The statute does not give a claimant any lien or other right to the withheld funds (unless a court so orders), so the lender should be free to declare the loan in default.  To facilitate this option ahead of time, the loan agreement could provide that the existence of a stop notice constitutes a default unless the borrower takes prompt action (by posting a payment bond or otherwise) to remove or satisfy the claim.

4. Stop Notices from the Owner’s Perspective.

   Because a stop notice seeks to interrupt the flow of financing, this is of serious concern to the borrower (usually the project owner).  The owner can pursue various strategies to avoid stop notices.  The owner can arrange for a payment bond in the amount of (at least) 50 percent of the interim or construction financing.  The owner can arrange to have the loan disbursed at an early date before any stop notices have been submitted.  The owner can require the prime contractor to protect the project against stop notices by posting a payment bond of its own or by promptly responding to stop notices as they are submitted.  The owner can also require the contractor to submit periodic lien releases from its major subcontractors and suppliers.

   If a stop notice is submitted despite these precautions, the owner (along with other interested parties) has a right to challenge it because it is “frivolous and made without reasonable cause, or is clearly excessive.”[19]  This statute parallels the language of the frivolous lien statute (RCW 60.04.081), and presumably, a court would treat the two parts of the lien statute as procedurally and substantively equivalent.  This means that a person challenging a stop notice under RCW 60.04.221(9) would bear a heavy burden to show that the stop notice was frivolous or excessive “beyond legitimate dispute.”[20]  The party who prevails in a challenge to a stop notice is entitled to a mandatory award of fees.

   It may well occur that a stop notice is procedurally invalid (e.g., submitted too late) or substantively invalid (e.g., the claim is subject to valid defenses), though the issues are not “beyond legitimate dispute.”  In such cases, the stop notice cannot be declared void using the summary procedure of RCW 60.04.221(9).  The validity of the stop notice will need to be resolved in litigation, usually the same litigation in which the claimant’s construction lien is foreclosed.  Because litigation over a stop notice raises questions of lien priority, fees should be awarded to the prevailing party.[21]

   One subsection of the stop notice statute says that a person shall be liable for “any loss, cost, or expense, including reasonable attorneys’ fees and statutory costs, to a party injured thereby [sic] arising out of any unjust, excessive, or premature notice filed under purported authority of this section.”[22]  This statute is intended to apply to (at least) the following kind of case:  a claimant submits a stop notice and, in response, the lender withholds substantial money that would otherwise have been disbursed to the project owner.  Lacking this money, the project owner is not able to pay other contractors, the project is delayed and damages accrue.  A court later determines that the claim underlying the stop notice was meritless and that the stop notice was submitted to exert unfair pressure on the owner to pay an unjustified claim.  In such cases, surely, the claimant may be held liable for the owner’s losses caused by the stop notice.[23]

   What happens in less extreme cases? The statute does not make it clear what evidence is required to establish that the stop notice was “unjust, excessive, or premature.”  Surely it is not enough that the stop notice claimant fails to receive any of the money withheld.  Consider the following scenario:  a claimant submits a stop notice for $10,000.  The lender withholds $10,000 from money that would otherwise have been disbursed and, as a result, the project is delayed and damages accrue.  The court later determines that the claimant was owed the $10,000, but this occurs in a lien foreclosure action involving multiple contending parties.  In the end, the property is sold and the court orders the sale proceeds, and the money is still held by the lender, to be disbursed to other parties whose claims are before those of the stop notice claimant.  It would seem that the stop notice claimant’s claim was not unjust, excessive, or premature, even though she failed to recover a money judgment, and she should not be liable for damages arising from project delays.  More than an unfavorable judgment should be required.  How much more may depend on the specific facts presented in future cases.

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[1] See generally RCW 60.04.221.

[2] See generally, Richard Paroutaud, Note: Mechanics’ Lien:  The “Stop Notice” Comes to Washington, 49 Wash. L. Rev. 685, (1974).

[3] See Cordell v. Regan, 23 Wash. App. 739, 746, 598 P.2d 416 (1979).

[4] RCW 60.04.011(6). The statute does not require that the lender of “interim or construction financing” be a bank or similar institution.

[5] RCW 60.04.221(1).

[6] See Cordell, 23 Wash. App. at 746 (construing prior statute).

[7] See RCW 1.12.040.

[8] In the case of noninstitutional lenders who lack an administrative office, presumably service is permitted at some appropriate business or home address.

[9] This phrase played a role under a previous version of the statute.

[10] Incidentally, it has been held that existence of the stop notice remedy does not prevent a contractor from pursuing a claim of unjust enrichment against a lender. See Town Concrete Pipe of Wash., Inc. v. Redford, 43 Wash. App. 493, 498, 717 P.2d 1384 (1986).

[11] RCW 60.04.221(5).

[12] As explained below, the statute provides remedies for false stop notices.

[13] RCW 60.04.011(3); see also Emerald City Elec. & Lighting, Inc. v. Jensen Elec., Inc., 68 Wash. App. 734, 846 P.2d 559 (1993) (lender’s disbursement for personal property was not a “draw” and so did not violate the stop notice statute).

[14] See Pac. Cont’l Bank v. Soundview 90, LLC, 167 Wash. App. 373, 273 P.3d 1009 (2012) (creating a reserve that did not result in any reduction of monthly draws did not comply with the stop notice statute).

[15] See In re Aspen Homes, Inc., 54 B.R. 541 (Bankr. E.D. Wash. 1985) (payments to suppliers and laborers counted as “draws” in violation of the stop notice statute).

[16] RCW 60.04.221(6).

[17] RCW 60.04.221(7) (stating that subordination follows if the lender fails to abide by “subsections (4) and (5) of this section”).  As noted by the code reviser, the reference should be to subsections (5) and (6). 

[18] See Pac. Cont’l Bank, 167 Wash. App. at 385 (quoting Town Concrete Pipe of Wash., Inc., 43 Wash. App. 493).

[19] RCW 60.04.221(9)(a).

[20] See supra, Chapter 6, Section 5, Challenging a Frivolous Lien Claim.

[21] See Emerald City Elec. & Lighting, Inc., 68 Wash. App. at 741 (construing prior statute).

[22] RCW 60.04.221(8).

[23] See Puget Sound Plywood, Inc. v. Mester, 86 Wash. 2d 135, 542 P.2d 756 (1975) (decided under prior similar statute).