Court Opinion

ID: 5488130
Source: CourtListenerOpinion
Date Created: 2022-01-10 02:19:58.836167+00
Date Added: 2024-06-11T08:33:42.966900
License: Public Domain

Graffeo, J. (concurring in part and dissenting in part).
I join that part of the majority opinion determining that the 2007 Loan Agreement was a building loan contract within the meaning of Lien Law § 22. However, because I read the plain language of the subordination penalty in this statute to apply to the lender’s “interest... in the real property”—the total mortgage and not just the portion attributable to construction funds—I respectfully dissent from the majority’s conclusion that $5.5 million of the loan proceeds was not subject to the subordination penalty.
As the majority explains, Lien Law § 22 establishes a recording requirement relating to a “building loan contract” as follows:
“A building loan contract either with or without the sale of land, and any modification thereof, must be in writing and duly acknowledged, and must contain a true statement under oath, verified by the borrower, showing the consideration paid, or to be paid, for the loan described therein, and showing all other expenses, if any, incurred, or to be incurred in connection therewith, and the net sum available to the borrower for the improvement, and, on or before the date of recording the building loan mortgage made pursuant thereto, to be filed in the office of the clerk of the county in which any part of the land is situated, except that any subsequent modification of any such building loan contract so filed must be filed within ten days after the execution of any such modification” (emphasis added).
*369As a consequence of the failure to comply with the recording requirement, Lien Law § 22 imposes what has come to be known as the subordination penalty, providing that if the building loan contract is “not so filed the interest of each party to such contract in the real property affected thereby, is subject to the lien and claim of a person who shall thereafter file a notice of lien under this chapter.” In other words, even though a lender’s mortgage might have been recorded first, if it was issued pursuant to a building loan contract that was not properly recorded, the lender’s mortgage loses its first-in-time priority and becomes subordinate to subsequently-recorded mechanic’s liens.
The recording requirement is intended to benefit contractors, laborers and material suppliers who work on construction projects. Its purpose is “to readily enable a contractor to learn exactly what sum the loan in fact made available to the owner of the real estate for the project” (Nanuet Natl. Bank v Eckerson Terrace, 47 NY2d 243, 247 [1979] [inclusion of false information in building loan contract that was recorded triggered subordination penalty]; see also Howard Sav. Bank v Lefcon Partnership, 209 AD2d 473, 476 [2d Dept 1994], lv dismissed 86 NY2d 837 [1995]), and to preclude lenders and owners from entering into “secret agreements” in that regard.
Plaintiff lender argues—and the majority accepts—that Lien Law § 22 does not require that the subordination penalty apply to the entire mortgage but covers only the portion relating to the advancement of construction funds. It further asserts that, since the purpose of the statute is to protect contractors, laborers and material suppliers, it makes no sense to preclude a lender from claiming priority with respect to the portion of the loan that had nothing to do with construction but related to the initial acquisition of the property. In my view, this argument should be rejected because the plain language of the statute directs that the full mortgage interest—not just the part securing the funds used for construction purposes—is subject to the subordination penalty, as two New York courts had held before the Appellate Division reached the same conclusion in this case (see Atlantic Bank of N.Y. v Forrest House Holding Co., 234 AD2d 491 [2d Dept 1996]; HNC Realty Co. v Golan Hgts. Devs., 79 Misc 2d 696 [Sup Ct 1974]).
Critically, Lien Law § 22 begins by indicating that the statute applies to “[a] building loan contract either with or without the sale of land,” thereby contemplating building loan agreements in which money is loaned both to purchase the property and *370construct improvements. Thus, just because some of the funds disbursed relate to the acquisition of the real property to be improved (or, in this case, the refinance of a mortgage previously used to acquire the real property to be improved), this does not prevent a loan agreement that otherwise meets the building loan contract criteria from being subject to the recording rule (as the majority also concludes). It is therefore clear that the legislature understood that there would be contracts like the one here where acquisition funds and construction monies would be addressed in a single loan secured by a mortgage. Nonetheless the subordination penalty that appears later in the statute does not include any language indicating an intent to exclude that portion of a mortgage securing acquisition funds from its scope. Rather, it provides, in broad terms, that “the interest of each party to such contract in the real property affected thereby, is subject to the lien and claim of a person” who later files a mechanic’s lien (Lien Law § 22 [emphasis added]). It is the “interest” of the lender “in the real property” that is subordinated to later-filed mechanic’s liens— and the lender’s interest in the real property is reflected in the entire mortgage, not merely a portion of it. As the Appellate Division explained in Atlantic Bank,
“if a lender fails to comply with the requirements of the Lien Law, its entire mortgage, including that part securing loan proceeds advanced for the purchase of the property, would become subordinate to any subsequently filed mechanic’s liens. This interpretation is consistent with the overriding concern that the lender is the party responsible for compliance and that the threat of the loss of priority is an effective deterrent against a lender shirking this responsibility ... To the extent that this outcome may be harsh, it must be understood that we are here dealing not with equitable redress, but with a statutorily imposed penalty” (Atlantic Bank, 234 AD2d at 492 [internal quotation marks and citation omitted]).
In arguing to the contrary, the lender relies on Yankee Bank for Fin. & Sav., FSB v Task Assoc., Inc. (731 F Supp 64 [ND NY 1990]), a federal district court decision that was issued before the Appellate Division decided Atlantic Bank. Although the majority finds this case to be persuasive, I believe that reliance is misplaced. First, as the majority acknowledges, in Yankee *371Bank neither party asserted that funds used for acquisition of the building were subject to the subordination penalty so the court was not confronted with the precise issue presented here. Second, without addressing the plain language in the subordination penalty, the District Court held in summary fashion that the lender retained its first priority interest in the foreclosure sale proceeds “only up to that amount actually expended toward the purchase of the . . . building,” with the remainder of its interest subordinated to the mechanic’s lienors (731 F Supp at 71-72). It is evident from a footnote that, rather than interpreting the subordination penalty itself, the court considered only the definitions of “building loan contract” and “building loan mortgage.” Noting (erroneously, in my view) that these definitions relate only to monies advanced for improvements on property, the court reasoned that “the proceeds from the loan which were lent for the purchase of the property [were] not subject to the subordination penalty” (731 F Supp at 71 n 2). But I believe that the Lien Law takes a more encompassing view. Section 22 makes clear that the subordination penalty applies to a building loan contract, regardless of whether it involves the sale of land, and then indicates it is the lender’s interest in the real property that is subordinated. The lender’s interest in the property is the total mortgage, not just the portion that correlates to the loan of construction funds. I therefore prefer the better-reasoned New York precedent.
Since the statutory language warrants a finding that the entire mortgage is subordinated when a building loan contract is not recorded, both Supreme Court and the Appellate Division properly concluded in this case that the lender’s $10 million mortgage was subordinate to the mechanic’s liens. Although this appears to wipe out any recovery for the lender, the legislature adopted this statutory penalty to dissuade lenders from engaging in the very conduct that occurred here: failing to comply with the building loan contract recording requirement. Here, none of the agreements relating to this loan were recorded: not the Loan Agreement, the Memorandum of Understanding nor Amendment No. 1, which was executed contemporaneously with the 2008 mortgage. And timely filing of documents and amendments is particularly necessary in cases such as this where aspects of the loan fail to close on time and material terms are amended while the project is ongoing—facts that can raise red flags to interested contractors, laborers and material suppliers if revealed.
*372I believe that the rule the majority has fashioned is antithetical to the purpose of the penalty and is likely to prove difficult to enforce. The subordination penalty is triggered when a lender fails to record a building loan contract or amendments thereto, or when information in filed agreements proves to be false. The burden it imposes on lenders is minimal—the statutory requirement is met merely by filing the pertinent documents in the county clerk’s office. One of the purposes behind the recording requirement is to make future contractors, laborers and material suppliers aware of the funds available for construction so that, prior to working on a project, they can make knowledgeable decisions concerning the amount of labor or materials to expend and the type of payment and security terms to demand. When acquisition funds are part of the loan, this necessarily diminishes the amount available to fund improvements on the real property. But if contractors are unaware of the extent to which the loan covers acquisition costs due to the failure to file a building loan contract, they may expend more labor and materials, and on different terms, than would have been the case had they been provided with the accurate information that the statute requires.
Moreover, if documents are not timely filed prior to the recording of the mortgage, resulting in the terms of the loan not being reflected in the public record, courts will be left to reconstruct the loan agreement between the lender and the building owner after the fact during a foreclosure action or other litigation when there may be disputes concerning the scope of the contract and the intent and effect of various written and oral modifications. This problem is apparent here where the lender’s view concerning the terms of the arrangement— whether certain documents were superceded or remained in effect—has evolved over the course of litigation and where the defaulting borrower did not participate and clarify the record. The bottom line is that, after a deal has gone south, it may be difficult to discern precisely what proportion of a loan was earmarked for acquisition expenses and what portion was actually expended for that purpose (a dispute of that kind apparently arose in Yankee Bank)—and the courts, as well as the contractors, laborers and material suppliers will be at the mercy of the parties to the loan to resolve the controversy. Timely recording of the proper documents when the loan occurs and prior to the filing of the mortgage obviates this problem. Of course, the subordination penalty will only come into play when that *373has not happened and I fear that the rule the majority adopts today will add to the confusion.
For all of these reasons, I conclude that the majority’s bifurcation rule unnecessarily complicates the application of the subordination penalty which, as constructed by the legislature, should be straightforward and require nothing more than giving the lender’s mortgage the priority it would have had if it had been recorded after the mechanic’s liens. The legislature appears to have made a considered decision that as between the lender, who could have protected its investment in full merely by timely recording its documents, and the contractors, laborers and material suppliers, who were inappropriately kept in the dark, it is the lender who should bear the loss. It is not for the courts to disturb that decision by creating a limitation on the subordination penalty that does not appear anywhere in the statute. Because the majority does so, I respectfully dissent from the majority’s opinion to the extent that it holds that $5.5 million of the loan proceeds was not subject to the subordination penalty.
Chief Judge Lippman and Judges Smith, Pigott and Rivera concur with Judge Read; Judge Graffeo dissents in part in an opinion; Judge Abdus-Salaam taking no part.
Judgment appealed from and order of the Appellate Division brought up for review modified, without costs, in accordance with the opinion herein and, as so modified, affirmed.