Every state’s laws provide protection to contractors, subcontractors, and material suppliers against non-payment for the goods or services they provide by allowing them to impose a lien on the property improved on.
These liens, known as mechanics liens, are placed on the property in an amount equal to the value of the goods or services rendered until the payment is received. Generally, for a lien to be enforceable, it must be recorded in the county where the property lies.
Once recorded in the public records, the lien appears on property title searches and, in some cases, takes precedence over a lender’s recorded lien. Therefore, lenders should be aware of state-specific statutes regarding mechanics liens and should understand how their interests can be protected.
Lien Priority – First in Time, First in Right
In most states, the “first in time, first in right” rule applies to property liens. This means that liens are given priority in the order that they are recorded in the specific county. In other words, a lien that is recorded first receives higher priority than subsequently recorded liens. Lien priority will determine the order in which debts are to be paid once a property is foreclosed on.
Typically, when a mortgage is recorded before a mechanics lien, that mortgage receives priority status over the mechanics lien. However, lenders should be aware that some states’ laws allow for certain property and special assessment tax liens, as well as certain HOA and COA assessment liens, to be given priority over recorded mortgages.
There are certain state-specific laws regarding the “first in time, first in right” rule. For example, in New York, the “first in time, first in right” rule is strictly enforced. If a mortgage is recorded before the recording of a mechanics lien, the mortgage will retain priority status.
In other states, such as in North Carolina, the date used to determine priority status on a mechanics lien will be based on the date that the work began, or when the goods were delivered, regardless of when the lien was officially filed with the county. In North Carolina, specifically, if materials are delivered or construction has begun on the property before the lender records his or her mortgage, any filed mechanics lien will have senior priority, even if recorded after the lender’s mortgage is recorded.
In other states, depending on the circumstances, a mechanics lien can take priority over any other pre-existing lien, including a mortgage, regardless of the filing date. In Oregon, for example, mechanics liens associated with new residential construction have blanket priority.
The rules may be different if the mortgage is associated with a construction loan. A construction loan mortgage could take priority over a mechanics lien if certain construction documents are filed before the mechanics lien is recorded. In this case, the mortgage filing date does not necessarily set the lien priority.
For construction loans, a lender can stay protected by obtaining a title insurance policy that includes coverage for mechanics liens, or that issues payments directly to the relevant vendor or contractor. Lien waivers can also be used. A lien waiver is a binding document that essentially serves as a “proof of payment.” Each time a payment is made, a lien waiver is executed, acknowledging receipt of the payment with a promise not to file a lien related to that amount.
Some states can shield lenders with “safe harbor” protections, allowing the mortgage lender to file for lien priority over a mechanics lien. Pennsylvania, for example, offers lenders safe harbor protection if the proceeds of the loan are used to pay all or part of the cost of the work in question.
Lenders: Be Aware
Lenders should be knowledgeable of state laws regarding lien priority. Lenders should also closely monitor construction projects on subject properties and obtain mechanics lien waivers whenever possible.