By: Daniel E. Fierstein and Jennifer M. Horn
Banks do not typically loan money if they can not be assured “priority” status over any other encumbrances that may arise. “Priority” in this context refers to the order in which various encumbrances, such as mortgages or mechanic’s liens, are paid off from the sale proceeds. As such, a question arises: what entity jumps to the front of the line when both a mortgage and a contractor-filed mechanic’s lien are present?
In the case of Commerce Bank/Harrisburg, N.A. v. Kessler, the Superior Court was presented with a question concerning priority under the Pennsylvania Mechanics’ Lien Law. This is the second contractor/subcontractor-friendly opinion of 2012 – the first being the Bricklayers case.
Commerce Bank/Harrisburg, N.A. v. Kessler
In Commerce Bank, Stephen and Lisa Kessler (the “Kesslers”) contracted with Michael Ricker (the “Contractor”) to build a luxury home in Harrisburg, in October 2006. In January 2007, the Kesslers contracted with Commerce Bank for a construction loan of up to $435,000.00 with an open-end mortgage. The Contractor broke ground on the project in October 2006, and Commerce Bank recorded the mortgage in January 2007.
The Kesslers failed to make payments to the Contractor and mortgage payments to Commerce Bank, which prompted the Contractor to file a mechanics’ lien claim on the property and obtain a judgment against the Kesslers. This also prompted Commerce Bank to file a mortgage foreclosure action and obtain a judgment against the Kesslers.
In 2010, Commerce Bank and the Contractor asked a trial court to suspend the foreclosure sale of the property and determine which party enjoyed priority over the other in connection with their respective judgments against the Kesslers. The trial court concluded that the Contractor’s lien enjoyed priority over Commerce Bank’s mortgage, and the Superior Court considered the issue on appeal.
Under the Pennsylvania Mechanics’ Lien Statute, for projects that involve new construction (as opposed to alteration or repair), a contractor’s lien takes effect for purposes of priority as of the date when the commencement of work is visible. However, a contractor or subcontractor’s lien becomes subordinate to an open-end mortgage when the proceeds of the loan are used to pay for the cost of completing construction.
Despite the fact that an open-end mortgage was in place, the Superior Court concluded that the Contractor’s lien enjoyed priority over Commerce Bank’s mortgage because not all of the proceeds from the mortgage were specifically used to cover the cost of construction. In other words, the Superior Court decided that if proceeds from an open-end mortgage are used to cover non-construction items such as closing costs, old mortgages or unpaid taxes, the open-end mortgage will not enjoy priority over a contractor or subcontractor’s mechanics’ lien where visible construction commenced prior to the lender’s recordation of mortgage.
This decision could have a significant impact on construction lending in Pennsylvania because, as discussed above, banks do not typically loan money if they cannot assure priority over any other encumbrances that may arise. This decision technically means that a lender’s priority over a contractor or subcontractor’s mechanics’ lien could be defeated if the contractor or subcontractor can demonstrate that at least one dollar of the proceeds from a construction loan were used to pay for expenses that are not considered costs of completing construction.
Ultimately, this issue remains unresolved because Commerce Bank has asked the Superior Court to reconsider its decision, and could seek to appeal the matter to the Supreme Court of Pennsylvania if it remains unsatisfied with the Superior Court’s decision.
Jennifer M. Horn is Senior Counsel at Cohen Seglias and a member of the Construction Group. She concentrates her practice in the areas of construction litigation and real estate.