Priority of Open-End Mortgages Over Mechanics’ Liens Limited

In Commerce Bank/Harrisburg, N.A. v. Kessler, 2012 WL 1610139 (Pa. Super. 2012), the Superior Court of Pennsylvania recently ruled on two issues of first impression: whether the amended version of the Mechanics Lien Law (“MLL”), 49 P.S. 1101, et seq., applies to contracts entered into prior to its January 1, 2007 effective date, and when a mechanics lien will have priority over an open-end mortgage.

The first issue addressed by the Court in Kessler applies to a limited number of loans- those for which contracts were entered into and visible commencement of work occurred prior to the January 1, 2007 effective date of the amended MLL, but the lien obtained after January 1, 2007. On this issue, the Court held that the applicable law was the amended MLL, since it was the law in effect at the time the contractors’ lien was filed; the law in place when construction began and the contract was entered into was not applied.

The broader issue addressed in Kessler is the Court’s interpretation regarding the statutory priority of open-end mortgages over mechanics liens. Kessler involved a construction loan where the project construction began in late 2006, but the lender’s open-end mortgage was not recorded until early 2007. The amended MLL provides that, although a mechanics lien for construction of improvements generally has priority as of the date of visible commencement of work, it is subordinate to an open-end mortgage “the proceeds of which are used to pay all or part of the cost of completing erection, construction, alteration or repair of the mortgaged premises…” . In Kessler, the mechanics lienholder argued, and the Court agreed, that an interpretation allowing any amount of loan proceeds to be used for purposes other than those expressly stated in the statute would create a situation where a minimal amount of proceeds could be used for construction and priority gained over a contractor, which was not the intent of the statute. Therefore, the Court determined that all of the loan proceeds secured by the open-end mortgage must have been used for the purposes expressly set forth in the amended MLL in order for the open-end mortgage to have priority over mechanics’ liens. In Kessler (and in many construction loans), loan proceeds were also used for closing costs, satisfaction of an existing mortgage, and payment of other judgments and liens. As a result, the Court held that the mechanics’ liens had priority over the lender’s open-end mortgage.

Kessler emphasizes the need for lenders to exercise caution in construction loan financing- if an open-end mortgage is recorded after work has commenced, and any loan proceeds are used for a purpose not expressly stated in the amended MLL, a mechanics lien claim will have priority (with the exception of projects where a waiver is applicable).

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