Balancing Act: Amendments to Pennsylvania Mechanics’ Lien Law Prioritize Open-End Mortgages Over Liens and Provide Added Protection for Residential Homeowners
In early July, Governor Tom Corbett signed Act 117 into law, approving new amendments to Pennsylvania Mechanics’ Lien Law. Act 117 amended the Lien Law in two critical ways: (1) the Act clarified that mechanics’ liens are subordinate to virtually all open-end construction mortgages; and (2) the Act created a new basis, a safe harbor, for owners of residential properties to discharge mechanics’ liens. The first of these two changes was made in response to the perceived shifting of power to contractors and subcontractors over owners and lenders following a recent appellate decision. The second change was made in response to the perception that contractors’ unscrupulous business practices were unfairly taking advantage of, and negatively impacting, homeowners. Act 117 is intended to rebalance the relative risks and power among owners, lenders, contractors, and subcontractors. In the process, however, Act 117 has potentially tipped the scale in favor of lenders and homeowners at the expense of contractors and subcontractors.
Commerce Bank/Harrisburg, N.A. v. Kessler
The first of the changes to the Mechanics’ Lien Law was precipitated by the Pennsylvania Superior Court’s holding in Kessler. That case involved a dispute regarding the priority of a mechanics’ lien, claimed by a contractor hired to build a home, relative to the open-end mortgage provided by the homeowner’s mortgage lender.
The contractor argued that its mechanics’ lien had priority over the lender’s mortgage. The mortgage lender, however, argued that its interest had priority under a 2007 amendment to the Mechanics’ Lien Law that provided that any mechanics’ lien would be 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 Superior Court rejected the mortgage lender’s argument because part of the loan proceeds provided by the lender were used to pay for, among other things, closing costs, satisfaction of an existing mortgage, and tax costs.
The Court found that the 2007 amendments only gave priority to open-end mortgages when all the proceeds of the mortgage are applied to the construction, alteration or repair of the home. The Court expressed some concern that lenders and homeowners might, under any contrary interpretation of the 2007 amendments, “manipulate the system to defeat lien rights.” Kessler tilted the scales in favor of contractors and subcontractors.
Act 117 Prioritizes Open-End Mortgages Over Liens
In direct response to Kessler, Act 117 expressly provides that open-end mortgages will take priority over any lien as long as at least sixty percent of the proceeds of the mortgage are used to pay all or part of the “costs of construction.” The term “costs of construction” is now defined to encompass a broad spectrum of costs including: government impact fees, legal fees, finance costs, closing fees, and escrow fees, in addition to the costs of erection, construction, alteration, or repair of the mortgaged premises. This clarification to the Mechanics’ Lien Law and its expansive, non-exhaustive definition of “costs of construction”, will likely mean that mechanics’ liens are now beneath open-end mortgages in the list of priority.
Prime Roofing LLC: “Unscrupulous Business Practices”
The second change was made in response to the perception that contractors’ unscrupulous business practices were causing residential homeowners to be unfairly surprised when subcontractors and suppliers, with whom the homeowners had no contact, filed liens on their property. One example for the revisions to Act 117 involved an out-of-state contractor taking advantage of Pennsylvania homeowners whose properties had been affected by a natural disaster. Prime Roofing LLC, a Texas company, started performing repair work in the Commonwealth after a tornado damaged multiple homes in western Pennsylvania. Although Prime Roofing completed its work on the subject homes, it failed to pay its roofing supplier. The roofing supplier, in turn, filed mechanic’s liens against the properties at issue, even though the homeowners had documentation showing they had fully paid Prime Roofing. Act 117 was passed out of a concern for these homeowners, and others like them, so that homeowners would be protected from “unscrupulous business practices.”
Act 117 Protects Residential Owners That Have Paid Their General Contractors
Concerned about the perceived unscrupulous business practices of contractors, Act 117 has also tipped the scales in favor of residential homeowners by establishing a new safe harbor against liens. Act 117 provides that no subcontractor will “have the right to file a lien with respect to an improvement to a residential property if… the owner or tenant paid the full contract price to the contractor.” Further, a residential owner may discharge any lien filed with respect to an improvement to the residential property as long as the owner has paid the full contract price to the contractor. When the owner has paid only a portion of the full contract price, then the owner may seek to reduce the lien in an amount equal to what has already been paid.
The change to lien priority and the safe harbor amendment to the lien law apply to any liens filed on or after September 9, 2014, even if work commenced before the effective date of the amendments. The amendments to the Mechanics’ Lien Law represent a rebalancing of the respective rights and burdens among construction lenders, owners, contractors, and subcontractors.
For the time being, it seems the scales have tilted toward lenders and owners. Accordingly, any contractors and subcontractors should remain vigilant of their rights under this new statutory regime and consider using other tools for ensuring payment. For example, if you are a subcontractor who performed work on a residential home and are owed money from a general contractor, you should consider requesting that payment from the owner be made via joint check. If you are a GC, by contrast, you should expect that disgruntled subcontractors may attempt to contact the owners directly, drawing suspicions from owners that their money is not being paid out properly, or worse, that the project may be delayed or left incomplete. GC’s should make certain to keep diligent records of all payments to subcontractors in order to demonstrate, if necessary, that all subcontractors and suppliers have been paid.
Editors’ Note: An additional amendment to the Lien Law was passed by the Pennsylvania Legislature on September 23, 2014, and is awaiting Governor Corbett’s signature. This amendment would establish an electronic system for filing “notices of furnishing” and would require that all subcontractors file an electronic notice of furnishing as a condition precedent to asserting any lien rights. For more on this amendment, follow our blog at Constructionlawsignal.com.
