Anatomy of a New York Building Loan

The New York Building Loan is the nexus, so to speak, of the state’s attempt to balance the respective interests of construction contractors and construction lenders, with both side’s interests in mind. If their objects and intentions become misaligned, the Building Loan can serve as a tool to navigate those competing interests.

What does some of this balancing look like?

On the Contractor’s end…

• A mechanics lien in New York “relates back” to the date the contractor first performed what it was hired to do for the project, even if the mechanics lien is filed afterwards.

• New York also has a “lien parity rule” which, with certain exceptions, puts contractors on equal footing with each other in terms of their ability to access the pot of available funds, regardless of the time their respective mechanics liens were filed.

On the Lender’s end…

• Mortgage lenders in New York can protect the priority of their loan advances against the potentially harsh one-two punch of the state’s “relation back rule” and its “lien parity rule” if, among other things, the mortgage securing those advances includes a statutory covenant by which loan advances are converted into a trust fund – a genius innovation that is essentially unique to New York.

• Construction lenders in particular are afforded further protections for certain types of “hard cost” advances if they structure the loans funding those advances as “Building Loans” in accordance with specific Lien Law requirements, including the requirement to record a “Building Loan Contract” and a “Section 22 Affidavit.”

• The essence of a Building Loan Contract is a statutorily required exchange of promises: the borrower’s promise to build improvements in exchange for the lender’s promise to advance funds to pay for certain costs of improvement. This exchange of promises is essential. No promise to build, no Building Loan Contract; no Building Loan Contract, no Lien Law protection for the Building Loan mortgage securing those advances.

• The main purpose of a Section 22 Affidavit is to give construction contractors notice of how much money is available from the Building Loan to pay for certain construction costs. This must be defined as a matter of public record and is referred to as a statement of the “net sum available” to contractors.

• A properly documented Building Loan, however, can only be used to pay for limited types of construction costs, defined by the Lien Law as a “cost of improvement.” However, the definition of “cost of improvement” is notoriously slippery.

• A Building Loan must not only be documented in a particular way, but even the order of recording of the Building Loan Contract, the Section 22 Affidavit and the Building Loan mortgage must be done with precision.

• And the modification of a Building Loan is also not a casual matter in New York. Making changes requires compliance with additional statutory rules, including most notably a requirement that the modification – if that modification is “material” – must be filed within 10 days of signing, seemingly straightforward requirements that are fraught with potential hidden pitfalls.

Failure to comply with Lien Law requirements for a Building Loan

If a lender fails to comply with the Lien Law requirements for a Building Loan or a Building Loan modification, the penalty can be quite harsh. A lender’s mortgage lien can end up subordinated to all mechanics liens, regardless of when filed.

Summary

New York’s Lien Law attempts to strike a balance between the potentially competing interests of construction contractors on the one hand, and construction lenders on the other. That balance is based on precise requirements that must be followed precisely, requirements whose goal is greater transparency through which the parties who intend to make a construction project a success can reasonably base their expectations of achieving that success.