Surprising Shakeup in Construction Lending: New Law Kisses Kessler Goodbye

On July 9, 2014, Governor Tom Corbett signed into law Act 117 of 2014 which amends the Mechanics’ Lien Law to grant lien priority to open-end mortgages over mechanics’ liens, provided that sixty percent (60%) of the proceeds of such mortgages are used for construction costs.

This amendment clarifies the 2012 Superior Court of Pennsylvania decision in Commerce Bank v. Kessler. In Kessler, the Court held that all proceeds of an open-end mortgage must be used for construction purposes in order for the open-end mortgage to be granted lien priority ahead of mechanics’ liens. Section 1508(c)(2) of the Mechanics’ Lien Law includes an exception to the priority of mechanics’ liens for “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 premise.” The Court in Kessler determined that in order for Section 1508(c)(2) to apply, all funds received under an open-end mortgage must be utilized for construction costs. Under Kessler, if a portion of the funds of an open-end mortgage were utilized for the acquisition of the property, soft costs or legal fees, for example, Section 1508(c)(2) would not apply and the open-end mortgage would not have lien priority.

The aftermath of Kessler left much uncertainty with respect to lien priority in construction lending. Title agencies, without clear guidance from the law, have been reviewing lien priority on a case by case basis, often resulting in inconsistencies for lenders and borrowers alike. Title agencies have been reluctant to remove the mechanics lien exception for fear of inadvertently impacting priority.

Act 117 clarifies this issue raised by the Kessler decision and amends the Mechanics’ Lien Law to provide priority to open-end mortgages so long as sixty percent (60%) of the proceeds of the mortgage are intended to pay all or part of the costs of construction. Act 117 will be effective beginning September 9, 2014 and will apply to mechanics’ liens filed on or after that date.

 

Topics:  Construction Contracts, Lending, Mechanics Lien

Published In: Construction Updates, Finance & Banking Updates, Residential Real Estate Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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