By Bruce Jervis
On a private construction project, the most valuable asset available to secure the project owner’s obligations is usually the property under development. The property secures the construction loan that finances the project. The property also serves as security, through mechanic’s liens, for contractor payment. So, when a project goes bad, who is first in line, the lender or the constructor?
Generally, the “first in time” rule applies. The timing is easy enough to establish with regard to the lien or deed of trust securing the construction loan. It is the date the document was filed in the appropriate property registry or office. With mechanic’s liens, however, it is not so simple. Regardless of the time of filing, a mechanic’s lien dates back to the day the contractor commenced work. Hence, the “first shovel” rule.
If construction loan security is filed after the contractor has made any visible improvement to the property, the contractor’s mechanic’s lien will usually take priority. Construction lenders act at their peril if they make loans after construction has commenced. This was illustrated in a recent case from the state of Washington.
A bank made a construction loan with knowledge that work was already under way. In a subsequent priority dispute, the bank conceded that the contractor’s mechanic’s lien up to the amount of the construction contract balance took priority. However, the bank argued that extra work, undocumented by written change orders, was outside the scope of the contract and did not take priority. The bank lost that argument. The full amount of the mechanic’s lien, including the extra work, took priority over the bank’s security interest.
Why would a construction lender knowingly assume a second priority position? Are lenders sometimes less than diligent in determining whether work has commenced? Is it fair that mechanic’s liens relate back in time to the first shovel of dirt and take priority over the construction lender? I invite your comments.
