Pennsylvania: Court Rules that Construction Loans may be Subordinate to Mechanics Liens

In the Pennsylvania Superior Court case (Commerce Bank v. Kessler), the court held that an open-end mortgage recorded after commencement of construction on the mortgaged property does not have statutory priority over a subsequently recorded mechanic’s lien unless all of the proceeds of the loan are used to pay the costs of completing erection, construction, alteration or repair of the mortgaged premises.

Construction lenders in Pennsylvania need to be aware of the impact of this ruling, namely that a lien filed by a contractor may have priority over an open-end construction mortgage when:

1. work on the property commenced prior to the recording of the mortgage
2. some of the proceeds of the mortgage are used for something other than the cost of completing erection, construction, alteration or repair of the mortgaged premises (such as to pay off a prior mortgage or to pay for real estate taxes or closing costs)

This case is already impacting how title companies are willing to insure construction mortgages in Pennsylvania. For example, one title company’s previous policy had been to treat an open-end mortgage that is used in part to pay the costs of construction as a “safe harbor” that would enable it to insure over mechanics’ liens. Because of this case, the standard has been revised such that underwriter approval will be required for mechanics’ lien coverage when a lender requests the title company to provide such coverage on a loan policy insuring an open-end construction mortgage, and it is determined that construction has already commenced or that construction is anticipated to commence prior to recording the mortgage.