Best Practices: Mechanics’ Liens 101 for SBA Lenders

When an SBA loan involves real estate, construction, renovations, or tenant improvements, mechanics’ liens should be a key consideration for SBA lenders. Although mechanics’ liens are generally governed by state law, they can directly affect lender’s collateral position. As such, understanding how they arise, and especially how their priority is determined, matters because work performed on a property before or after closing can end up competing with the lender’s own security interest.

At its core, a mechanics’ lien is a statutory tool that protects the people who actually build things: contractors, subcontractors, laborers, and material suppliers who improve real property and haven’t been paid for it. What makes these liens tricky for lenders is timing. In many states, a mechanics’ lien can jump ahead in priority based on when the work began, not when the lien itself was recorded. Most states have adopted some version of this look-back approach, though the specifics differ from state to state. Accordingly, lenders should consult experienced counsel to understand how the applicable state’s mechanics’ lien laws may affect the priority of their security interest.

That variability has real implications for underwriting, particularly around title insurance. Lenders should scrutinize title commitments closely for mechanics’ lien exceptions and push the title company to either remove those exceptions, provide affirmative coverage, or otherwise confirm that unrecorded lien rights won’t cut into the lender’s mortgage position.

And the work doesn’t end at closing. Even in situations where title issues are addressed, mechanics’ lien exposure follows the construction timeline. Indeed, it’s worth thinking of ongoing construction activity as a collateral risk the lender has a stake in, not just an operational matter for the borrower to manage alone. In practice, that means building real disbursement controls into the process: contractor affidavits, lien waivers, payment affidavits, sworn statements, and updated title searches before releasing subsequent advances.

Although mechanics’ liens will rarely be the flashiest item during the closing process, they’re one of the few risks that can undo a lender’s priority position through no fault of the loan documents themselves. A better approach is to get ahead of the issue before closing and stay engaged with it through the construction process. And while no two projects are exactly alike, a proactive lender who treats construction draws as checkpoints, rather than formalities, is the one who catches a problem early while it’s still cheap to fix thereby avoiding any priority disputes while at the same time protecting the value of the collateral in the event of borrower’s default.

For further assistance please contact the attorneys at Starfield & Smith, P.C. at 215-542-7070 or email us at info@starfieldsmith.com.