Balancing Mortgage and Mechanics Lien Priorities in New York

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PART I OF A SERIES:
Commercial Real Estate Finance in New York

In this series, Robert Riva navigates the nuanced and often confusing world of commercial real estate finances in New York, with practical guidance on challenges and considerations.

In an ideal world, the interests of contractor and lender involved in the same construction project are aligned: the project succeeds, and everyone is paid what they’re owed.

But when the interests of contractor and lender become misaligned – because both have benefited the same real property but there isn’t enough money to repay them both – we have a problem.

And that problem is of such importance, that New York – like all states – long ago devised a way of trying to balance the competing interests of contractor and lender that goes beyond the rights each may have against the property owner who brought them into the project in the first place.

That balancing tries to coordinate two distinct types of security interest:

• The contractor’s security interest in the form of a mechanics lien against the real property it benefits; and
• The lender’s security interest in the form of a mortgage lien against the real property it finances.

If a contractor isn’t timely paid, it has the right to foreclose on its mechanics lien, and likewise a lender whose loan isn’t timely repaid has the right to foreclose on its mortgage lien, in either case forcing the sale of the property to satisfy the unpaid amount.

But what if contractor and lender each needs to foreclose their respective liens at the same time?

Different states try to resolve such potential conflicts between contractor and lender in different ways, with different priorities for the two types of security interests:

• Some states’ lien priority regimes favor contractors, while those of other states are more lender-friendly.
• New York’s is somewhere in between, but with unique twists – the “Relation Back” Rule and the “Lien Parity” Rule.

NEW YORK’S “RELATION BACK” RULE:

• If a contractor in New York does what New York law requires it to do, its mechanics lien relates back to the date the contractor first did what it was hired to do for the project (as opposed to the date it was supposed to be paid, or some other date).
• If a lender in New York does what New York law requires it to do, its mortgage lien can slice into that relation-back structure, disrupting it and gaining priority over mechanics liens that are filed after its mortgage was filed.

New York’s “Lien Parity” Rule:

• When multiple mechanics liens are filed against a construction project in New York, they’re not ranked in priority according to the date each notice of lien was filed. There’s no “race to the courthouse,” so to speak, among mechanics lienholders. The earliest filed mechanics lien shares its priority status with all later-filed mechanics liens that relate to the same construction project.
• What this means is that all mechanics lienholders share equally in available assets – that is, they share them “on a parity.”
• In this way, all contractors that are owed money share in the same pot, with equal priority – assuming of course that there’s enough money in that pot when the priority liens are foreclosed.

The concern over lien priority, however, is precisely the issue, and not just for a contractor, but for the lender as well:

• The foreclosure of a lien on real property – whether a mechanics lien or a mortgage lien – essentially eliminates all junior liens, clearing them off title to the property along with any junior lienholder’s unsatisfied rights to repayment from the sale of the property.
• If that junior lienholder is a mortgage lender on a New York construction project, the lien parity rule becomes a potential nightmare in that even mechanics liens filed after the mortgage could “jump” the lien priority of the mortgage.

We delve into some of these challenges – what they mean and how they’re typically addressed – in upcoming installments of this series.