Posts in Mechanic's Liens

December 21, 2012
Commercial Construction Mortgages Stand Tall Over Later-Recorded Mechanic’s Liens In Indiana

The law is well settled in Indiana concerning the priority of mechanic’s liens and commercial construction mortgages.  The 2011 opinion of City Savings Bank v. Eby Construction, 954 N.E.2d 459 (Ind. Ct. App. 2011) reaffirmed the Court’s 2008 decision in McComb & Son v. JPMorgan Chase, about which I have written.  Construction mortgages prime mechanic’s liens on commercial projects, assuming the lender recorded its mortgage before the contractor recorded its mechanic’s lien.

The usual suspects.  The facts in City Savings were undisputed and not terribly unique.  The case involved a real estate owner/borrower, a lender/mortgagee and a subcontractor/mechanic’s lien holder.  In 2005 and again in 2007, the lender made two construction loans to the owner and contemporaneously filed two mortgages.  The funds from the lender’s mortgage loans were for the specific commercial project that gave rise to the subcontractor’s mechanic’s lien.  In 2008, after failing to get paid, the subcontractor recorded a mechanic’s lien. 

The litigation context.  At the trial court level of the City Savings foreclosure case, both the subcontractor and lender claimed their respective lien had priority over the other.  Despite the McComb precedent in favor of the lender, the trial court gave the mechanic’s lien priority based upon laws of equity.  (Black’s Law Dictionary defines “equity” as “justice administered according to fairness as contrasted with the strictly formulated rules of common law.”)  On appeal, after citing to McComb and the three operative statutes (Ind. Code §§ 32-21-4-1(b), 32-28-3-2 and, most importantly, 32-28-3-5(d)), the Court reversed the trial court in favor of the lender.

Unclean hands.  What distinguishes City Savings from McComb is the Court’s analysis of the subcontractor’s equity-based arguments around Section 5(d).  The subcontractor asserted the equitable doctrine of “unclean hands.”  In Indiana, that doctrine “provides that one who seeks relief in a court of equity – [foreclosure actions are essentially equitable in nature] – must be free of wrongdoing in the matter before the court.”  The subcontractor, Eby, contended:

[Lender] supplied the [owner] with proceeds from a third promissory note to pay a subcontractor, Vendramini, for its improvements to the Real Estate knowing full well that Eby remained unpaid by the [owner] for Eby’s improvements.  The payments to Vendramini occurred after Eby had already recorded its mechanic’s lien and after Eby had filed its complaint to foreclose to which [lender] was made a party.  The trial court frowned upon the fact that [lender] “essentially authorized the payment of a third contractor before the second contractor.”  As [lender] was on notice of Eby’s mechanic’s lien before it disbursed those funds on behalf of the [owner], the trial court concluded that [lender] was in the best position to avoid a loss in this case. 

Equity vs. law.  The Court did not condone the owner’s decision to pay Vendramini when it had not yet paid Eby.  But the Court did not view such a decision as unclean hands on the part of the lender, which was under no obligation to control its borrower’s decisions.  Moreover, the Court did not believe that the owner’s decision to put the lender in a better position than Eby should negate the lender’s statutory priority status.  In a pro-lender, pro-legislature statement, the Court said:

The Real Estate was clearly encumbered by [lender’s] first recorded mortgage at the time Eby contracted with the [owner] to provide improvements.  Eby knew that the Real Estate was commercial property, that it was encumbered by a mortgage, and that the loans secured by the mortgage were for the specific construction project that gave rise to Eby’s mechanic’s lien.  Eby was in the best position to avoid a loss because, at the time of contracting, Eby knew exactly what kind of lien it would be getting regarding its improvements to the Real Estate:  an inferior one.

A separate equitable doctrine in Indiana provides that “equity follows the law.”  In City Savings, principles of equity could not overcome the clear application of the statutory law in favor of the lender.  There was no evidence that substantial justice could not be accomplished by following the law.  Since Indiana’s priority statutes governed the parties’ actions, “equity must follow the law.”   

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Posted at 05:00 PM in Mechanic's Liens , Mortgages  |  Permalink

May 31, 2012
Lender’s Preservation Expenses Prime Mechanic’s Lien

Problems with construction mortgage loan defaults can be compounded by deterioration in the collateral when contractors stop working due to non-payment.  In certain cases, a lender might utilize a formal receivership to finish the project during the pendency of a foreclosure case.  In other cases, the expense of a receivership may not be warranted, or the lender may have no interest in funding the completion of the job.  Sometimes, only short-term repairs such as winterization are needed.  Does a lender’s claim for such direct advancements have priority over a mechanic’s lien claim?  Robert Neises Construction v. Kentland Bank, 2010 Ind. App. LEXIS 2449 (Ind. Ct. App. 2010) addressed that issue.

Chronology.

05/13/08       The borrower executed promissory note in favor of the bank in the amount of $193,000 and simultaneously delivered a mortgage against the subject real estate.  The $193,000 was to be used to construct a single-family residence.

04/2008        The borrower hired a contractor to construct the residence, and work began.

07/07/08      The bank recorded its mortgage.

07/14/08       The contractor filed a mechanic’s lien against the subject real estate in the amount of $22,369.

10/21/08        The contractor filed a complaint to foreclose its mechanic’s lien and named the bank.

12/11/08         The bank filed a counterclaim, crossclaim and third-party claim seeking to foreclose its mortgage on the subject real estate.

12/23/08         The bank filed an emergency motion to access the subject real estate and asserted that, pursuant to the terms of its mortgage, the bank had a right to preserve and protect the subject real estate.  The bank alleged that the contractor had stopped construction and had left the property in jeopardy of being destroyed or damaged due to weather.  Subsequently, the bank paid a separate contractor $20,188.91 to install a roof on the subject real estate and protect the structure from the elements.

Preservation expense super priority lien?  The question was whether the bank’s expenditures to protect the subject real estate from damage during the foreclosure case had priority over the mechanic’s lien.  There was no Indiana precedent or any specific statute providing the basis for the “preservation expenses” to be a super priority.  The Court in Neises Construction relied on the general principle that trial courts in Indiana mortgage foreclosure actions have “full discretion to fashion equitable remedies that are complete and fair to all parties involved.” 

Ruling.  Here is how the Court ruled:

It is undisputed, then, that [the bank] paid for the installation of a roof and other protective measures meant to preserve the integrity of the unfinished house, which benefited each of the lienholders.  There is no suggestion that the expenses were unreasonable or that the protective measures were otherwise ill-conceived.  Indeed, [the contractor] never objected to [the bank’s] emergency motion, so it cannot now complain.  Because [the bank], [the contractor] and the other lienholders were engaged in a common enterprise, and each benefited from the protective measures for which [the bank] bore the full expense, the trial court properly exercised its equitable powers to give [the bank] priority for preservation expenses over [the contractor] and the others in its distribution of the proceeds from the sheriff’s sale.

In short, since the bank’s “new money” helped everyone, the lien for the preservation expenses was senior. 

Parity scenario.  The Court noted that, in Indiana, a mortgage for construction of a house has the same priority as a mechanic’s lien where the mortgagee and the mechanic’s lien holder are engaged “in a common enterprise and neither of them is in a position to claim priority.”  Pursuant to Ward v. Yarnell, about which I have discussed previously, the bank’s and the contractor’s underlying liens were held in parity, but the bank’s preservation expense advancement maintained a separate and distinct senior status.  The contractor felt that even the new money to winterize the house should fall into the parity calculation, but the Court rejected the argument.  (Had Neises Construction been a commercial project, there would have been no dispute because parity wouldn’t enter the equation.  Pursuant to a separate statutory provision, the lender’s mortgage lien would be senior.  Since Neises Construction involved a residential project, Ward’s parity rule applied and thus created the opening for the contractor to at least fashion an argument.) 

In similar situations, and assuming a mortgage provision supports it, lenders involved in failed construction projects in Indiana can be assured that preservation expenses they advance will hold super priority status, generally superior to most all other liens except for delinquent real estate taxes.  Neises Construction also illustrates that a formal receivership isn’t always necessary to preserve and protect the property during foreclosure.

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Posted at 01:21 PM in Mechanic's Liens , Mortgages  |  Permalink

February 03, 2010
Mortgage Securing Residential Subdivision Development Primes Site Work Mechanic’s Liens

Today’s post follows up my July 3, 2007, July 7, 2007 and September 6, 2008 posts dealing with the priority of commercial construction mortgages over mechanic’s liens.  If you are struggling with lien priority questions related to the development of a residential subdivision, the Indiana Court of Appeals’ decision in Lincoln Bank v. Conwell Construction, 2009 Ind. App. LEXIS 1047 (Ind. Ct. App. 2009) (Lincoln.pdf) provides answers.

The interests.  Nichols Group owned real estate that it intended to develop into a residential subdivision.  Lincoln Bank gave a mortgage loan to Nichols Group to fund the development, and the bank recorded its mortgage in 2006.  General contractor, Conwell Construction, contracted with Nichols Group to develop the site (earth work, sewer, water, curbs and paving).  Conwell Construction, in turn, contracted with subcontractors Hedger (for curbs), Mitchell (for drains) and Grady (for paving).  The contractors only performed site development work.  They did not construct any houses, nor did they improve any specific lots.  Indeed no houses were ever built on the property.  Since the contractors didn’t get paid, they filed mechanic’s liens in 2007. 

The controversy.  The Court addressed the question of whether Lincoln Bank’s mortgage should have priority, as opposed to the bank and the four contractors sharing pro rata in any foreclosure proceeds.

Inventory of statutes.  Lincoln Bank, a thorough and logical opinion, addresses the applicable Indiana statutes:

 a. I.C. § 32-28-3-1 – Contractors may file mechanic’s liens for, among other
  things, the labor and materials at issue.

 b. I.C. § 32-28-3-5(c) – Mechanic’s liens are equal in priority to other
  mechanic’s liens.

 c. I.C. § 32-28-3-5(d) – Priority of construction mortgages (see also July 11, 2007
  and September 6, 2008 posts).

 d. I.C. § 32-28-3-5(d)(1-3) – Exceptions to general rule of construction mortgage
  priority for homes, improvements auxiliary to homes and utilities.

Section 5(d) and its three categories of exceptions.  The Court noted that a recorded mortgage has priority over a subsequently-recorded mechanic’s lien, per I.C. § 32-28-3-5(d), “to the extent of the funds actually owed to the lender for the specific project to which the lien rights relate.”  There was no dispute Lincoln Bank recorded its mortgage before the recordation of the mechanic’s liens, nor was there a dispute that Lincoln Bank’s mortgage “was for the specific project to which the lien rights relate.”  Therefore, if § 5(d) applied, Lincoln Bank’s mortgage would have priority over the mechanic’s liens.  The Lincoln Bank decision focused on the three stated carve outs in § 5(d) for construction (1) of houses, (2) of improvements auxiliary to houses and (3) on property controlled by a utility.  For those categories, Ward v. Yarnelle would control, meaning that there would be parity among the mortgage and the mechanic’s liens.

Exceptions not applicable.  Since the underlying site development work in Lincoln Bank related to the ultimate construction of houses, seemingly the door was open for the Court to apply one or more of the three exceptions to § 5(d)’s priority rule.  Instead, the Court viewed the work for what it was – construction, for a real estate investor, of a commercial project.  The work in question did not directly involve the building of an individual homeowner’s residence.  The closest call for the Court was § 5(d)(2), which governs the development or construction of “an improvement on the same real estate auxiliary to a Class 2 structure [house].”  Despite concluding that the contractors’ earth moving operations and asset installations were indeed “improvements,” the Court relied heavily on the fact that “no home had yet been constructed on the land” in concluding that § 5(d)(2) “does not apply to preparing land for the subsequent construction of houses.” 

Result.  The Court concluded, with regard to the foreclosure proceeds, that “the first priority is to satisfy Lincoln Bank’s mortgage.”  Thereafter, “the four mechanic’s liens are equal in priority.”  Lincoln Bank is particularly relevant today given recent failures of many residential subdivision development projects across Indiana.  These projects have, in certain instances, stalled before any houses were built or any specific lots were improved.  According to Lincoln Bank, where the general contractor or subcontractors have devoted resources only to subdivision site work, lenders holding a timely and perfected construction mortgage will not be forced to share equally with such contractors. 

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Posted at 04:03 PM in Mechanic's Liens  |  Permalink

September 07, 2008
Blog Post On Priority Of Commercial Construction Mortgages “Affirmed On Appeal”

My July 3, 2007 blog post entitled “Construction Mortgage v. Mechanic’s Lien:  Win, Lose or Draw?” addressed Indiana’s rules applicable to a hypothetical priority dispute between a construction mortgage lender and a contractor in a commercial project.  Based upon my research and analysis at that time, my theory was:

2007: Lender Wins.  At least as to a standard commercial project, therefore, the Ward doctrine of parity seems to be a thing of the past.  The lender, in the scenario presented to me, shouldn’t be forced to share equally with any contractors that started construction before the developer closed the deal.  Instead, the lender should hold a superior lien, assuming the lender records his mortgage before a contractor records a notice of mechanic’s lien.  In other words, if the project goes south, the lender should get paid first.  Having done all the research and reasonably assured myself of the answer to the question, therefore, I believe my lender contact can relax.  Minimal delays with the closing should not adversely affect his bank’s mortgage lien.  But, he should make sure he records the mortgage sooner rather than later, and certainly before any of the contractors record a notice of mechanic’s lien.

This past Wednesday, in a case of first impression in Indiana, the Court of Appeals in McComb & Son v. JPMorgan Chase, Case Number 02A04-0802-CV-60 (McComb.pdf), reached the same conclusion I did.

The situation.  The parties involved in McComb & Son were two general contractors (McComb and ARI), who had entered into a construction agreement with the property owner (Indian Village) to develop an apartment complex.  Lender JPMorgan Chase Bank (Chase) extended an $850,000 line of credit and a $2,650,000 construction loan to Indian Village.  Indian Village failed to pay McComb/ARI and also defaulted on its construction loan with Chase.  Significantly, Chase had recorded its mortgages before McComb/ARI recorded their mechanic’s lien notices.

The statutes.  Indiana law is well-settled that Chase had priority over McComb/ARI with regard to the land and the pre-existing buildings.  The only issue in McComb & Son was whether McComb/ARI had priority as to the improvements they constructed.  The Court outlined the three operative statutes and the corresponding rules/exceptions:   

1.  Generally, a purchase money mortgage is superior to a mechanic’s lien “if the mortgage was recorded before the mechanic’s work was begun or materials furnished.”  Provident Bank v. Tri-County South Side Asphalt, Inc., 804 N.E.2d 161, 163 (Ind. Ct. App. 2004); I.C. § 32-21-4-1(b).

2.  But, a mechanic’s lien holder has priority “as to the improvement for which he provided the labor and materials.”  Provident Bank, 804 N.E.2d at 164; I.C. § 32-28-3-2.  “The holder of a mechanic’s lien may sell the improvements to satisfy the lien and remove them within ninety days of the sale date.”  Thus a mechanic’s lien has priority over a purchase money mortgage with regard to “new improvements” even if the mortgage was recorded before the mechanic’s lien notice was recorded and even if the mortgage was recorded before the mechanic’s lien holder began its work or furnished any materials.

3.  On the other hand, as to commercial property (including apartment complexes), the mortgage of a lender has priority over all liens recorded after the date the mortgage was recorded, “to the extent of the funds actually owed to the lender for the specific project to which the lien rights relate.”  I.C. § 32-28-3-5(d) . 

For the first time, McComb & Son conclusively tells us what Section 5(d) means.  The Court talked about Ward v. Yarnelle, 91 N.E.7 (Ind. 1910) and its doctrine of parity, as well as the dissenting opinion in the Provident Bank case, both of which I addressed in July of 2007.  According to McComb & Son, the Ward doctrine of parity does not apply to commercial construction projects.  The critical rule announced in McComb & Son was: 

With regard to commercial property, where the funds from the loan secured by the mortgage are for the specific project that gave rise to the mechanic’s lien, the mortgage lien has priority over the mechanic’s lien recorded after the mortgage.

The conclusion.  Chase’s mortgages had priority over McComb/ARI’s mechanic’s liens because:

There is no dispute that [Chase’s] mortgages were recorded before the Lienholders’ mechanic’s liens or that the property in question is commercial in nature.  In addition, the trial court … concluded that the funds from [Chase’s] loan were for the specific project that gave rise to the Lienholders’ mechanic’s liens. 

Although McComb/ARI may seek transfer of the case to the Indiana Supreme Court, for now a lender’s construction mortgage lien will prime a mechanic’s lien, if the lender records its mortgage before any contractor records its notice of mechanic’s lien and if the construction project was commercial in nature. 

The survival of the Provident Bank rule (#2 above).  McComb/ARI argued for application of the Provident Bank rule, but Provident Bank did not involve a construction loan but rather a purchase money mortgage.  As such, I.C. § 32-28-3-5(d) did not apply.  Significantly, however, the Court explicitly stated that I.C. § 32-28-3-2 “still provides the general rule” in cases where the funds from the loan secured by the mortgage were not for the construction of the improvement. 

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Posted at 10:46 PM in Mechanic's Liens  |  Permalink