By Jones Osborn II

Most people involved in the real estate industry have a basic knowledge of mechanics' and materialmen's liens. However, many property owners do not know whether construction carried on by their tenant can create a lien against their property.

First, a little background. Arizona law provides that every person who labors or furnishes professional services, materials, machinery, fixtures, or tools in the construction, alteration, or repair of any building may assert a lien against the property if not paid. This means, for example, that if a lumberyard delivers lumber to a building site for incorporation into a building but is not paid when the bill comes due, the lumberyard may record a lien against the property. It may then foreclose on that lien in a manner similar to foreclosing on a mortgage. The sheriff would sell the property at the completion of the foreclosure and the proceeds would be used to pay lienholders, including the holder of any mechanics' and materialmen's liens against the property, in the order of their priority. The balance, if any, would be paid over to the owner.

Building owners often lease space to a tenant--be it an office, shopping center, or industrial building--knowing that the tenant is going to make improvements to the leased space. Usually, the lease will expressly give the tenant permission to make certain improvements, or may require the tenant to obtain the landlord's approval of the plans before beginning any improvements or alterations. As a result, landlords are often concerned about the exposure of their property to liens if the tenant encounters financial difficulties and fails to pay his suppliers, contractors, and laborers.

In most cases, the landlord has little to worry about if he is aware of the law and handles the situation properly. Here are the ground rules:

1. The general rule is that the landlord's property is not subject to liens for improvements done by the tenant, even if the landlord knew of or consented to the work.

2. The first exception is when the lease requires the tenant to make improvements. In this case, the landlord's property becomes subject to mechanics' and materialmen's liens if the tenant doesn't pay for the work.

3. The second exception is when the tenant is the landlord's agent in having the work done, provided that the agency can be proven by clear and convincing evidence. If an actual agency relationship can be proven, the landlord's property may be subject to liens.

4. Even if the landlord's property is not liable for liens, the tenant's leasehold estate will be if the tenant doesn't pay his bills. Any lien claimant foreclosing on the tenant's leasehold estate would, of course, have to pay the landlord his rent and comply with the other terms of the lease, so this remedy is of limited value and is rarely exercised.

Conclusion. If you are a landlord, be very careful before you sign a lease requiring your tenant to make improvements, because this can subject your property to liens. And if you do require such improvements, either require the tenant to file a bond against liens or take steps to insure that all contractors, professionals, workers and suppliers are paid and lien waivers obtained as the job progresses.