Source: https://commercialforeclosureblog.typepad.com/indiana_commercial_forecl/mechanics-liens/
Timestamp: 2019-04-25 00:14:57+00:00

Document:
Legal issue. Whether a leasehold mortgage or mechanic’s lien had priority in title.
Vital facts. A lessee of real estate and a contractor entered into a construction contract on 7/30/13 to build a fertilizer plant. Construction began on 10/25/13. Lessee later needed additional financing for the construction. On 5/16/14, the lessee granted a bank a leasehold mortgage as collateral for some financing the bank offered through a series of master leases between the bank and the lessee. The bank recorded its mortgage on 6/24/14. Following the lessee’s failure to pay the contractor in full, the contractor recorded a mechanic’s lien on 3/6/15. Collection and foreclosure litigation subsequently commenced against the lessee that included a lien priority dispute between the bank and the contractor.
Procedural history. The bank filed a motion for summary judgment claiming that its mortgage should receive priority over the contractor’s mechanic’s lien. The trial court granted the motion, and the contractor appealed.
Three statutes: There are three Indiana statutes that govern priority between a mortgage and a mechanic’s lien: Indiana Code Sections 32-21-4-1(b), 32-28-3-2 and 32-28-3-5(d).
With regard to commercial property, where the funds from the loan secured by the mortgage are for the specific project that gave rise to the mechanic’s lien, the mortgage lien has priority over the mechanic’s lien recorded after the mortgage.
Holding. The Indiana Court of Appeals affirmed the trial court’s summary judgment in favor of the bank/mortgagee. The Indiana Supreme Court denied transfer.
Policy/rationale. The heart of the Kellam dispute surrounded the nature of the financing. The contractor argued, among other things, that the lessee did not execute a promissory note and that the security agreement was not a qualifying mortgage because the document’s title was a “leasehold” mortgage. The Court, however, found that the agreement operated like a typical mortgage by granting a lien on the lessee’s property rights and by obligating the lessee to repay the bank for funds the bank expended. Moreover, there was no authority for the proposition that a promissory note is required for a valid mortgage.
In the final analysis, despite the unconventional (my term) nature of the financing arrangement, the Court in Kellam was convinced that the lessee sought a loan from the bank for construction of the facility and that the bank’s funds were used for that purpose. Since the Lender Exception applied, the bank’s mortgage was superior to the contractor’s mechanic’s lien.
Related posts. The Mechanic's Liens category to your right contains all of my posts about these kinds of priority disputes.
I represent lenders, as well as their mortgage loan servicers, entangled in lien priority disputes and contested foreclosures. If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenlawyers.com. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.
Lesson. In Indiana lien priority disputes, a purchase money mortgage fares better than a subsequent mechanic’s lien. Contractors beware.
Case cite. Wells Fargo v. Rieth-Riley, 38 N.E.3d 666 (Ind. Ct. App. 2015) .
Legal issue. As between a mortgagee and a mechanic’s lienholder, whose lien has priority? And, how does Indiana view each party’s remedy vis a vi the real estate? Note this case did not involve a construction mortgage (see posts below), which the law treats differently.
Vital facts. Wells Fargo involved a shopping center. Lender refinanced the purchase of the subject real estate and held a mortgage, which lender recorded on the real estate in January of 2008. In 2011, the center’s owner hired contractor to pave the shopping center’s parking lot. After failing to receive payment, contractor recorded a mechanic’s lien on the real estate. Neither lender nor contractor got paid, so a foreclosure lawsuit ensued against the center’s owner.
Procedural history. The case mainly dealt with the dispute between lender and contractor as to which party’s lien had priority, together with their respective remedies. The trial court entered a complicated summary judgment spelling out the treatment of the parties’ interests in the real estate. Lender appealed.
Key rules. A mortgage takes priority according to the time of its filing. Ind. Code 32-21-4-1(b). The effective date of a mechanic’s lien relates back to the date the contractor began work. I.C. 32-28-3-5. A mortgage generally takes priority over a mechanic’s lien if the mortgage was recorded before the contractor began its work.
In instances of a purchase money mortgage, the exception to the general rule arose out of the Provident Bank v. Tri-County Southside Asphalt case decided by the Court of Appeals in 2004 (and discussed in a post below). That case established that Indiana’s mechanic’s lien statute at I.C. 32-28-3-2 protects contractors by providing priority over a purchase money mortgage “as to the improvement for which he provided the labor and materials.” Provident Bank went on to hold that the contractor “may sell the improvements to satisfy the lien and remove them” following the sale. Provident Bank, not unlike Wells Fargo, surrounded paving work (a driveway). The contractor had a senior lien over the driveway (only) and, as absurd as it seemed, the Court concluded that the contractor could sell and remove the driveway to satisfy its lien.
Holding. The Indiana Court of Appeals in Wells Fargo first held that, generally, lender’s mortgage had priority over the contractor’s lien for the simple reason that the lender recorded its mortgage earlier. Contractor was not entitled to a pro-rata share of the proceeds from the sale of the real estate, as contractor had contended and as other states, such as Illinois, allow.
Policy/rationale. Indiana public policy in these cases places the risk of loss on the party best able to avoid the loss. “A mechanic performing work on property encumbered by a mortgage may easily determine whether the property upon which he will work is encumbered before deciding whether to perform the work.” Someone has to lose, and Indiana favors lenders. In my view, the absurdity of the “improvement removal” remedy for contractors serves to force the parties to settle the case.
Further, I should note that Wells Fargo is a novel decision in that it extends the Provident Bank analysis to mandate a trial court determination of whether removal of the subject improvement is “practical,” which in Wells Fargo meant “that its removal will not substantially impair the value of the land beyond that which it would have been had the parking lot never have been paved.” Absent a “practical” removal, the mechanic’s lien will be fully primed by the purchase money mortgage.
Construction Mortgage vs. Mechanic’s Lien: Win, Lose or Draw?
The law is well settled in Indiana concerning the priority of mechanic’s liens and commercial construction mortgages. The 2011 opinion of City Savings Bank v. Eby Construction, 954 N.E.2d 459 (Ind. Ct. App. 2011) reaffirmed the Court’s 2008 decision in McComb & Son v. JPMorgan Chase, about which I have written. Construction mortgages prime mechanic’s liens on commercial projects, assuming the lender recorded its mortgage before the contractor recorded its mechanic’s lien.
The usual suspects. The facts in City Savings were undisputed and not terribly unique. The case involved a real estate owner/borrower, a lender/mortgagee and a subcontractor/mechanic’s lien holder. In 2005 and again in 2007, the lender made two construction loans to the owner and contemporaneously filed two mortgages. The funds from the lender’s mortgage loans were for the specific commercial project that gave rise to the subcontractor’s mechanic’s lien. In 2008, after failing to get paid, the subcontractor recorded a mechanic’s lien.
The litigation context. At the trial court level of the City Savings foreclosure case, both the subcontractor and lender claimed their respective lien had priority over the other. Despite the McComb precedent in favor of the lender, the trial court gave the mechanic’s lien priority based upon laws of equity. (Black’s Law Dictionary defines “equity” as “justice administered according to fairness as contrasted with the strictly formulated rules of common law.”) On appeal, after citing to McComb and the three operative statutes (Ind. Code §§ 32-21-4-1(b), 32-28-3-2 and, most importantly, 32-28-3-5(d)), the Court reversed the trial court in favor of the lender.
[Lender] supplied the [owner] with proceeds from a third promissory note to pay a subcontractor, Vendramini, for its improvements to the Real Estate knowing full well that Eby remained unpaid by the [owner] for Eby’s improvements. The payments to Vendramini occurred after Eby had already recorded its mechanic’s lien and after Eby had filed its complaint to foreclose to which [lender] was made a party. The trial court frowned upon the fact that [lender] “essentially authorized the payment of a third contractor before the second contractor.” As [lender] was on notice of Eby’s mechanic’s lien before it disbursed those funds on behalf of the [owner], the trial court concluded that [lender] was in the best position to avoid a loss in this case.
The Real Estate was clearly encumbered by [lender’s] first recorded mortgage at the time Eby contracted with the [owner] to provide improvements. Eby knew that the Real Estate was commercial property, that it was encumbered by a mortgage, and that the loans secured by the mortgage were for the specific construction project that gave rise to Eby’s mechanic’s lien. Eby was in the best position to avoid a loss because, at the time of contracting, Eby knew exactly what kind of lien it would be getting regarding its improvements to the Real Estate: an inferior one.
Problems with construction mortgage loan defaults can be compounded by deterioration in the collateral when contractors stop working due to non-payment. In certain cases, a lender might utilize a formal receivership to finish the project during the pendency of a foreclosure case. In other cases, the expense of a receivership may not be warranted, or the lender may have no interest in funding the completion of the job. Sometimes, only short-term repairs such as winterization are needed. Does a lender’s claim for such direct advancements have priority over a mechanic’s lien claim? Robert Neises Construction v. Kentland Bank, 2010 Ind. App. LEXIS 2449 (Ind. Ct. App. 2010) addressed that issue.
05/13/08 The borrower executed promissory note in favor of the bank in the amount of $193,000 and simultaneously delivered a mortgage against the subject real estate. The $193,000 was to be used to construct a single-family residence.
04/2008 The borrower hired a contractor to construct the residence, and work began.
07/07/08 The bank recorded its mortgage.
07/14/08 The contractor filed a mechanic’s lien against the subject real estate in the amount of $22,369.
10/21/08 The contractor filed a complaint to foreclose its mechanic’s lien and named the bank.
12/11/08 The bank filed a counterclaim, crossclaim and third-party claim seeking to foreclose its mortgage on the subject real estate.
12/23/08 The bank filed an emergency motion to access the subject real estate and asserted that, pursuant to the terms of its mortgage, the bank had a right to preserve and protect the subject real estate. The bank alleged that the contractor had stopped construction and had left the property in jeopardy of being destroyed or damaged due to weather. Subsequently, the bank paid a separate contractor $20,188.91 to install a roof on the subject real estate and protect the structure from the elements.
It is undisputed, then, that [the bank] paid for the installation of a roof and other protective measures meant to preserve the integrity of the unfinished house, which benefited each of the lienholders. There is no suggestion that the expenses were unreasonable or that the protective measures were otherwise ill-conceived. Indeed, [the contractor] never objected to [the bank’s] emergency motion, so it cannot now complain. Because [the bank], [the contractor] and the other lienholders were engaged in a common enterprise, and each benefited from the protective measures for which [the bank] bore the full expense, the trial court properly exercised its equitable powers to give [the bank] priority for preservation expenses over [the contractor] and the others in its distribution of the proceeds from the sheriff’s sale.
In short, since the bank’s “new money” helped everyone, the lien for the preservation expenses was senior.
In similar situations, and assuming a mortgage provision supports it, lenders involved in failed construction projects in Indiana can be assured that preservation expenses they advance will hold super priority status, generally superior to most all other liens except for delinquent real estate taxes. Neises Construction also illustrates that a formal receivership isn’t always necessary to preserve and protect the property during foreclosure.
Today’s post follows up my July 3, 2007, July 7, 2007 and September 6, 2008 posts dealing with the priority of commercial construction mortgages over mechanic’s liens. If you are struggling with lien priority questions related to the development of a residential subdivision, the Indiana Court of Appeals’ decision in Lincoln Bank v. Conwell Construction, 2009 Ind. App. LEXIS 1047 (Ind. Ct. App. 2009) (Lincoln.pdf) provides answers.
The interests. Nichols Group owned real estate that it intended to develop into a residential subdivision. Lincoln Bank gave a mortgage loan to Nichols Group to fund the development, and the bank recorded its mortgage in 2006. General contractor, Conwell Construction, contracted with Nichols Group to develop the site (earth work, sewer, water, curbs and paving). Conwell Construction, in turn, contracted with subcontractors Hedger (for curbs), Mitchell (for drains) and Grady (for paving). The contractors only performed site development work. They did not construct any houses, nor did they improve any specific lots. Indeed no houses were ever built on the property. Since the contractors didn’t get paid, they filed mechanic’s liens in 2007.
The controversy. The Court addressed the question of whether Lincoln Bank’s mortgage should have priority, as opposed to the bank and the four contractors sharing pro rata in any foreclosure proceeds.
things, the labor and materials at issue.
and September 6, 2008 posts).
priority for homes, improvements auxiliary to homes and utilities.
Section 5(d) and its three categories of exceptions. The Court noted that a recorded mortgage has priority over a subsequently-recorded mechanic’s lien, per I.C. § 32-28-3-5(d), “to the extent of the funds actually owed to the lender for the specific project to which the lien rights relate.” There was no dispute Lincoln Bank recorded its mortgage before the recordation of the mechanic’s liens, nor was there a dispute that Lincoln Bank’s mortgage “was for the specific project to which the lien rights relate.” Therefore, if § 5(d) applied, Lincoln Bank’s mortgage would have priority over the mechanic’s liens. The Lincoln Bank decision focused on the three stated carve outs in § 5(d) for construction (1) of houses, (2) of improvements auxiliary to houses and (3) on property controlled by a utility. For those categories, Ward v. Yarnelle would control, meaning that there would be parity among the mortgage and the mechanic’s liens.
Result. The Court concluded, with regard to the foreclosure proceeds, that “the first priority is to satisfy Lincoln Bank’s mortgage.” Thereafter, “the four mechanic’s liens are equal in priority.” Lincoln Bank is particularly relevant today given recent failures of many residential subdivision development projects across Indiana. These projects have, in certain instances, stalled before any houses were built or any specific lots were improved. According to Lincoln Bank, where the general contractor or subcontractors have devoted resources only to subdivision site work, lenders holding a timely and perfected construction mortgage will not be forced to share equally with such contractors.
2007: Lender Wins. At least as to a standard commercial project, therefore, the Ward doctrine of parity seems to be a thing of the past. The lender, in the scenario presented to me, shouldn’t be forced to share equally with any contractors that started construction before the developer closed the deal. Instead, the lender should hold a superior lien, assuming the lender records his mortgage before a contractor records a notice of mechanic’s lien. In other words, if the project goes south, the lender should get paid first. Having done all the research and reasonably assured myself of the answer to the question, therefore, I believe my lender contact can relax. Minimal delays with the closing should not adversely affect his bank’s mortgage lien. But, he should make sure he records the mortgage sooner rather than later, and certainly before any of the contractors record a notice of mechanic’s lien.
This past Wednesday, in a case of first impression in Indiana, the Court of Appeals in McComb & Son v. JPMorgan Chase, Case Number 02A04-0802-CV-60 (McComb.pdf), reached the same conclusion I did.
The situation. The parties involved in McComb & Son were two general contractors (McComb and ARI), who had entered into a construction agreement with the property owner (Indian Village) to develop an apartment complex. Lender JPMorgan Chase Bank (Chase) extended an $850,000 line of credit and a $2,650,000 construction loan to Indian Village. Indian Village failed to pay McComb/ARI and also defaulted on its construction loan with Chase. Significantly, Chase had recorded its mortgages before McComb/ARI recorded their mechanic’s lien notices.
1. Generally, a purchase money mortgage is superior to a mechanic’s lien “if the mortgage was recorded before the mechanic’s work was begun or materials furnished.” Provident Bank v. Tri-County South Side Asphalt, Inc., 804 N.E.2d 161, 163 (Ind. Ct. App. 2004); I.C. § 32-21-4-1(b).
2. But, a mechanic’s lien holder has priority “as to the improvement for which he provided the labor and materials.” Provident Bank, 804 N.E.2d at 164; I.C. § 32-28-3-2. “The holder of a mechanic’s lien may sell the improvements to satisfy the lien and remove them within ninety days of the sale date.” Thus a mechanic’s lien has priority over a purchase money mortgage with regard to “new improvements” even if the mortgage was recorded before the mechanic’s lien notice was recorded and even if the mortgage was recorded before the mechanic’s lien holder began its work or furnished any materials.
3. On the other hand, as to commercial property (including apartment complexes), the mortgage of a lender has priority over all liens recorded after the date the mortgage was recorded, “to the extent of the funds actually owed to the lender for the specific project to which the lien rights relate.” I.C. § 32-28-3-5(d) .
There is no dispute that [Chase’s] mortgages were recorded before the Lienholders’ mechanic’s liens or that the property in question is commercial in nature. In addition, the trial court … concluded that the funds from [Chase’s] loan were for the specific project that gave rise to the Lienholders’ mechanic’s liens.
Although McComb/ARI may seek transfer of the case to the Indiana Supreme Court, for now a lender’s construction mortgage lien will prime a mechanic’s lien, if the lender records its mortgage before any contractor records its notice of mechanic’s lien and if the construction project was commercial in nature.
The survival of the Provident Bank rule (#2 above). McComb/ARI argued for application of the Provident Bank rule, but Provident Bank did not involve a construction loan but rather a purchase money mortgage. As such, I.C. § 32-28-3-5(d) did not apply. Significantly, however, the Court explicitly stated that I.C. § 32-28-3-2 “still provides the general rule” in cases where the funds from the loan secured by the mortgage were not for the construction of the improvement.
Following-up my July 3 post concerning a potential priority dispute between a construction lender and a contractor, I thought it might be beneficial to set out the key statutes in full. Here are the provisions, both of which are in Indiana's mechanic's lien statute.
"Extent of lien; leased or mortgaged land"
Sec 2. (a) The entire land upon which the building, erection, or other improvement is situated, including the part of the land not occupied by the building, erection, or improvement, is subject to a lien to the extent of the right, title, and interest of the owner for whose immediate use of benefit the labor was done or material furnished.
the lien, so far as concerns the buildings erected by the lienholder, is not impaired by forfeiture of the lease for rent or foreclosure of mortgage. The buildings may be sold to satisfy the lien and may be removed not later than ninety (90) days after the sale by the purchaser.
"Recording notice; priority of lien"
(4) any other entity that has the authority to make loans.
(b) The recorder shall record the statement and notice of intention to hold a lien when presented under section 3 of this chapter in the miscellaneous record book. The recorder shall charge a fee for recording the statement and notice in accordance with IC 36-2-7-10. When the statement and notice of intention to hold a lien is recorded, the lien is created. The recorded lien relates back to the date the mechanic or other person began to perform the labor or furnish the materials or machinery. Except as provided in subsections (c) and (d), a lien created under this chapter has priority over a lien created after it.
(c) The lien of a mechanic or materialman does not have priority over the lien of another mechanic or materialman.
(1) A Class 2 structure (as defined in IC 22-12-1-5).
(2) An improvement on the same real estate auxiliary to a Class 2 structure (as defined in IC 22-12-1-5).
(B) intended to be used and useful for the production, transmission, delivery, or furnishing of heat, light, water, telecommunications services, or power to the public.
My partner Tom Hanahan, who often represents lenders on the front end of construction deals, informs me that title companies in Indiana usually will not insure absolute priority over mechanic's liens, where construction has commenced before recording of the mortgage, without securing indemnity from the principals of the borrower. In speaking with Tom, I gather that the title lawyers have noted the potentially-inconsistent language in Ind. Code 32-28-3-5 and 32-28-3-2, about which I discussed in my prior post. I highlighted the areas of potential conflict. Judge for yourself.
Recently, I met with a commercial lender who mentioned a problem with one of his projects. Construction had started, but the developer hadn’t closed the construction loan. Thus the lender’s mortgage hadn’t been recorded, but likely would be soon. He wondered how the delay might affect the priority of his bank’s mortgage lien. Secured lenders involved in real estate development in Indiana probably should be aware of some of the rules governing these situations.
1910: A Draw. The Indiana Supreme Court’s 1910 decision in Ward v. Yarnelle, 91 N.E.7 (Ind. 1910) is the landmark opinion on this subject. At the time, Indiana’s mechanic’s lien statute “failed to address the lien priority between a [construction mortgage] and the mechanic’s liens of those who [completed] the construction.” In Re Venture, 139 B.R. 890, 895 (N.D. Ind. 1990). The Court therefore announced the equitable “doctrine of parity” in which a “real estate mortgage executed while a building was in the process of construction was entitled to equal priority with the claims of [contractors that] worked after [recordation] of the mortgage and with full knowledge of its purpose and effect.” Beneficial Finance v. Wegmiller Bender, 402 N.E.2d 41, 47 (Ind. Ct. App. 1980) (no parity because contractor completed its work before lender recorded its mortgage); Brenneman Mechanical v. First Nat. Bank, 495 N.E.2d 233, 242 (Ind. Ct. App. 1986) (parity because contractors had knowledge of loan, which helped pay them).
1999: Statutory Amendments. Ind Code §32-28-3-5 is the pivotal statute. Subsection (b) provides that a mechanic’s lien is “created” when the lien notice is recorded. But the recorded lien relates back to the date the work began, which could pre-date a mortgage. In 1999, Indiana’s legislature added the language now in subsection (d) that says construction mortgages have priority over mechanic’s liens if the mortgage is recorded before the notice of mechanic’s lien is recorded (not created). My reading is that subsection (d) disposes of Ward’s doctrine of parity, at least as to commercial and industrial projects. (Note that section 5(d)(1)-(3) has carve-outs for certain residential and utility projects.) Accordingly, Indiana courts should focus on relative filing dates, and not on work dates or contractor knowledge.

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