EARLY START; OR THE MORTGAGE VERSUS MECHANIC'S LIEN PRIORITY QUESTION

During the past summer, builders may have seen a reluctance by some title insurance companies and lenders to give builders approval for an early start. Until recently, many title insurance companies and lenders gave select builders the approval to start work on a project before the construction loan was closed. That trend seems to be changing with builders finding it more and more difficult to start projects before financing is in place.

The early start problem arises because of the law on priority of Mechanic's Liens and Mortgages. A Mortgage takes its priority at the time the Mortgage is recorded. Mechanic's Liens get their priority based on when the "actual and visible beginning of the improvement on the ground" has taken place. All Mechanic's Liens take their priority from the first day visible work is done on the property. If visible work has started on the project before the Mortgage has been recorded, everyone from the excavator to the cabinet and mirror installer will have a Mechanic's Lien that is prior to the Mortgage.

If the project is completed and everyone paid, the priority does not make a difference. If the project goes broke, and a Mechanic's Lien lawsuit is filed, the title insurance company must step in to protect the priority of the Mortgage. If there is not sufficient equity in the property to pay both the Mechanic's Liens and the Mortgage, and if visible work was done on the property before the Mortgage was recorded, the title insurance company may end up paying the Mechanic's Liens.

Builders who were in business in the mid to late 1980s may remember that banks and title insurance companies were very concerned that no work be done on the property until the Mortgage was recorded. Some time in the mid 1990s, title companies and some banks got a little lax. The economy was booming and very few projects were getting into trouble.

In the last year or so, projects have gotten into trouble and title insurance companies have paid out many hundreds of thousands of dollars to settle Mechanic's Lien claims. Payment was required because the title company allowed an early start on a project. This allowed Mechanic's Liens to get priority over the Mortgage, and the title company had to pay the Mechanic's Liens to protect the Mortgage.

Now, it seems that title companies have tightened up and even long time builder customers may not start any work until the title company is satisfied that the Mortgage is recorded. A builder who starts work early may find that it will not be possible to get Mortgage financing or title insurance coverage.

In my experience, title insurance companies are willing to take some risks, and when times are good, perhaps they take too many risks. Title companies and lenders have recently decided to pull back and are demanding strict adherence to the no early start rules so that the Mortgage can be guaranteed to have priority over the Mechanic's Lien.

Waiting to start a project can be inconvenient and, in some cases, the builder might think it doesn't make sense. It might be helpful to keep in mind that title insurance rates, like rates for comprehensive, general liability insurance, are based largely on losses. If the title insurance industry begins to pay out large sums of money in Mechanic's Lien disputes, they will have no alternative, but to increase the premiums that builders or their customers will pay for title insurance.

©2003 Rinke-Noonan Law Firm and David J. Meyers, St. Cloud, Minnesota.

David J. Meyers is licensed to practice law in the State and Federal Courts in Minnesota and Wisconsin. He is certified as a Real Property Law Specialist. He is a former BAM President and Member of the BAM Board of Directors, and currently serves on the CMBA Board of Directors.