On July 9, 2014, Pennsylvania Governor Tom Corbett signed into law Act 117 of 2014, which amends the Pennsylvania Mechanics' Lien Law (MLL), 49 P.S. 1101, et seq., to provide that a construction loan secured by an open-end mortgage where at least 60 percent 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.
The amendment to the MLL is in response to the Pennsylvania Superior Court's May 2012 ruling in Commerce Bank/Harrisburg, N.A. v. Kessler, which effected fundamental change in the previously understood priority of open-end construction loan mortgages over mechanics' liens. At the time of the Kessler decision, the MLL 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.
Now, in addition to clarifying that loan proceeds may be used for purposes other than construction costs, an expansive definition of "costs of construction" has been added to the MLL, which encompasses 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;
- legal, architect, engineering, consulting, accounting, management and 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, as long as the threshold requirement for payment of the loan proceeds to "costs of construction" is met. These amendments should allow lenders and title insurers to make sure the "super-priority" is applicable, based on review of the construction loan budget.
If you have any questions about this Alert, please contact Jonathan M. Petrakis, Louise S. Melchor, any of the attorneys in our Bank and Financial Institution Representation Practice Group or the attorney in the firm with whom you are regularly in contact.
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