PA Mechanics Lien Law Amended to Clarify Open-End Construction Loan Mortgage Priority

In May 2012, the Pennsylvania Superior Court issued its decision in Commerce Bank/Harrisburg, N.A. v. Kessler, effecting fundamental change in the previously understood priority of open-end construction loan mortgages over mechanics liens. At the time of the Kessler decision, the Mechanics Lien Law (“MLL”), 49 P.S. 1101, et seq. provided that, although a mechanics lien for construction of improvements generally has priority as of the date of visible commencement of work, it was 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…”. The Kessler court interpreted the statute to mean that, in order for the exception to priority to be applicable, all of the loan proceeds secured by the open-end mortgage must be used for such “hard costs,” and none of the loan proceeds could be used for other purposes, such as closing costs, satisfaction of an existing mortgage, or payment of other judgments and liens. As a result of the Kessler decision, lenders have sought to structure transactions to allow for title insurance coverage against mechanics liens for construction loans when visible work commenced prior to the mortgage recording date.

On July 9, 2014, Governor Corbett signed into law Act 117 of 2014, which amends the MLL to provide that a construction loan secured by an open-end mortgage where at least 60% of the proceeds are “intended to pay or used to pay” all or part of the “costs of construction” will have lien priority ahead of any filed mechanics lien claims, even when the visible commencement of work was prior to the recordation of the open-end mortgage. And, an expansive definition of “costs of construction” has been added to the MLL, including all costs, expenses and reimbursements pertaining to erection, construction, alteration, repair, mandated off-site improvements, government impact fees and other construction-related costs, including, but not limited to, costs, expenses and reimbursements in the nature of taxes, insurance, bonding, inspections, surveys, testing, permits, legal fees, architect fees, engineering fees, consulting fees, accounting fees, management fees, utility fees, tenant improvements, leasing commissions, payment of prior filed or recorded liens or mortgages, including mechanics liens, municipal claims, mortgage origination fees and commissions, finance costs, closing fees, recording fees, title insurance or escrow fees, or any similar or comparable costs, expenses or reimbursements related to an improvement, made or intended to be made, to the property.

Act 117 further provides that these amendments will apply to mechanics liens perfected on or after the Act’s effective date of September 7, 2014, including liens relating to construction of an improvement for which the visible commencement of work occurred prior to the effective date.

Once Act 117 is in effect, open-end mortgages for construction loans where proceeds are used for purposes other than “hard costs” will regain their “super-priority” over mechanics liens, so long as the threshold requirement for payment of the loan proceeds to “costs of construction” is met. And, these amendments will allow lenders and title insurers to ensure the “super-priority” is applicable, based on review of the construction loan budget.

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The opinions expressed on this blog are those of the author and are not to be construed as legal advice.

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