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March 8, 2017

Best Practices: Protecting Your Mortgage’s Priority From Mechanic’s Liens

by Katherine D. Tohanczyn

Mechanic’s lien laws are statutes that exist in every state to protect contractors, subcontractors and material suppliers that furnish work or materials to construction projects. As the name suggests, these laws allow contractors, subcontractors and suppliers to impose a lien on an owner’s property if the property has been improved by the goods, labor or services supplied, but payment has not been made. The lien is recorded in public property records, appears on a title search of the property and, in some instances, can take priority over a lender’s recorded mortgage. As such, it is vital that lenders recognize and understand the state specific laws regarding mechanic’s liens and when they can intervene in the lender’s security interest priority.

To determine the impact of a mechanic’s lien, a lender first needs to determine when a mechanic’s lien attaches to the subject property and whether a mechanic’s lien is considered superior to other liens. In property law, generally, one’s lien position is based upon the order in which one properly records a notice of the lien in the county records where the property is located. This rule is known as the first in time, first in right rule. Some states, such as New York, strictly follows the first in time, first in right rule, meaning so long as a mortgage is recorded prior to the filing of a mechanic’s lien, the mortgage will have senior priority. However, there are additional requirements for construction loan mortgages in order for it to have priority over mechanic’s liens, such as recording of the construction loan agreement and other documentation regarding the construction.

Other states have adopted the concept that the mechanic lien attaches at a time when the work begins, even if it is prior in time to when a the mechanics lien is filed in the public records. For example, in North Carolina, a mechanic’s lien dates back to the first day that the contractor or subcontractor brings materials or rental equipment to the property or the day the contractor or subcontractor begins working on the project. In this situation, if labor or materials are supplied to the site, or if construction begins prior to the recording of a mortgage, and a mechanic’s lien is subsequently filed, the mechanics lien will have senior priority over the mortgage.

Although rare, a few states have taken the position that in certain circumstances mechanics lien have blanket priority over all pre-existing liens, regardless of when the liens were filed. For example, in Oregon liens for labor or materials supplied on new residential construction have such super priority.

If a lender finds itself in a position where a mechanics lien could take priority, it should determine whether the state provides a “safe harbor” protection to the lender allowing the lender to obtain lien priority over the mechanic’s lien. In Pennsylvania, the safe harbor subordinates after-filed mechanics’ lien claims to the lien of open-end mortgages if “the proceeds of [the loan] are used to pay all or part of the cost of completing erection, construction, alteration or repair of the mortgaged premises.”

A lender’s failure to either perfect or protect its appropriate lien position as required by the SBA Authorization could be the basis of the SBA’s repair or denial of a guaranty purchase request. To protect its guaranty, lender’s financing construction projects in states that prioritize mechanic’s liens should research the laws of that state, and closely monitor the construction project and collect mechanics liens waivers to the extent allowed by statute.

For more information on mechanic’s liens and priority issues, please contact Katherine at ktohanczyn@starfieldsmith.com or at 267-470-1187.