A common question posed by out-of-state lenders making a real estate secured loan in Maryland involves the creditor-friendly mechanic’s lien statute. The question is often posed in two parts: whether (i) the establishment of a Mechanic’s Lien can prime the lien priority of subsequent construction advances secured by a recorded, first-lien deed of trust on real property and (ii) a lender’s title insurance policy will insure the continuity of the lender’s first lien against a subsequent Mechanic’s Lien.
In short, no and yes. In Maryland, construction advances secured by a deed of trust on real property relates back to the time and priority of the lien of the deed of trust so as to “squeeze out” the intervening rights of third parties, including a contractor or subcontractor that has established a Mechanic’s Lien on the property. A lender’s title insurance policy will cover the priority of the full amount of the loan secured by the deed of trust against a subsequently established Mechanic’s Lien.
To insure it receives timely and complete payment, a contractor or subcontractor engaged to complete a construction project (in either case, a “claimant”) can establish a lien encumbering the property being improved, known as a “Mechanic’s Lien”, which, if not timely paid, can result in foreclosure. In Maryland, a claimant must utilize the court system, following procedural requirements, to establish a Mechanic’s Lien as opposed to the claimant obtaining a lien by virtue of simply commencing work or furnishing materials.
Procedurally, a claimant must file a petition to establish a Mechanic’s Lien in the Circuit Court where the project land is located within 180 days of the days of completing the work or furnishing material. Notably, while a contractor does not need to provide prior written notice to an owner before filing, a subcontractor must, within 120 days of completing the work or furnishing material, send the owner a “Notice of Intention to Establish a Lien” (a “Notice”) before filing its petition. A contractor or subcontractor (once its Notice is properly given) then has ninety (90) days from the petition filing, to “show cause” at a hearing based on the documents attached to and the facts described in the petition. Once the court determines that are reasonable grounds for the lien to attach, it will issue a show cause order to the owner to dispute whether the lien should attach. An owner will then need to timely file an answer or counter-affidavit disputing the claimant’s petition and raising defences such as payment or partial payment or failure to receive notice (for petitions filed by subcontractors). Failure to do so results in the claimant’s petition for a Mechanic’s Lien being granted. Notably, in Maryland, there is no “defense of payment” for owners for petitions filed by subcontractors. Rather, the burden rests on the owner to guarantee that all subcontractors are paid. If an owner pays a general contractor in full, but that general contractor fails to pay the subcontractors, subject to compliance with the mechanic’s lien statute, those subcontractors will still be able to enforce a lien against the property.
In addition to the above procedural requirements to establish a lien, the contractor’s work or materials must comply with certain statutory requirements with respect to the facts provided in its petition. Among other things, the work performed or materials provided have to relate to [a] “building erected” or [a] “building repaired, rebuilt or improved” so long as the value of the work or materials totals at least fifteen percent (15%) of the building’s value. In addition, the building and land subject of the claimant’s petition must be correctly identified. Because in Maryland a mechanic’s lien is an “in rem” proceeding, meaning it involves the property of the person and not the person itself, correctly identifying the property and building is more important than identifying the owner. Certain additional nuances need to be met for claims by contractors or subcontractors to establish a Mechanic’s Lien on a leasehold interest or condominium units.
Once a court determines the claimant is entitled to a Mechanic’s Lien, within one year of such order, the claimant must file a separate motion to enforce the Mechanic’s Lien against the property. The creation of the right to enforce against the property by court order is important because it established the priority of the Mechanic’s Lien in relation to other liens encumbering the property.
The lender’s deed of trust will state the principal amount of the loan regardless of whether loan proceeds will be funded at closing, or in several subsequent advances, to ensure the priority of the full loan amount over subsequent liens. As Maryland law does not distinguish between optional versus obligatory advances as they relate to the priority of future advances, once the first lien priority of the construction deed of trust is established, all subsequent liens, including a subsequently-established Mechanic’s Lien will always be junior to any subsequent advances made under the construction documents and secured by the construction deed of trust. Upon a foreclosure of a construction deed of trust, any junior liens would be extinguished. Accordingly, a claimant possessing a Mechanic’s Lien can only recover if the foreclosed property is sold in excess of the amount owed on the first lien construction loan.
Because Maryland law provides that the priority of future advances under construction loans relate back to the time of the loan, title companies insuring construction loans in Maryland are comfortable insuring the full amount of the construction loan against intervening liens. Title coverage for construction loan priority over subsequent mechanic’s liens is found in Covered Risks Item 11 on the standard ALTA Loan Policy jacket (6/17/06), which provides a lender coverage for the “Amount of Insurance” notwithstanding that the construction loan will be advanced in one or more disbursement as of the “Date of Policy”, which reads as follows:
“The lack of priority of the lien of the Insured Mortgage upon the Title: (a) as security for each and every advance of proceeds of the loan secured by the Insured Mortgage over any statutory lien for services, labor, or materials arising from construction of any improvement or work related to the Land when the improvement or work is either (i) contracted for or commenced on or before the Date of Policy; or (ii) contracted for, commenced or continued after Date of Policy if the construction is financed, in whole or in part, by proceeds of the loan secured by the Insured Mortgage that the Insured has advanced or is obligated on Date of Policy to advance; . . . (emphasis added)”
As a further result of Maryland’s favorable treatment of future advances relative to subsequent liens, title companies are generally not tasked by construction lenders to disburse construction loan draws and related tasks, such as issuing a title date down endorsement to the loan policy increasing the amount of coverage.
In spite of Maryland’s favorable treatment of subsequent advances as they relate to subsequent liens, it is, nevertheless, prudent for a construction lender to nonetheless reserve its right to require, as a condition to subsequent construction draws, Borrower to provide an updated title report to ascertain whether any subsequent liens have been filed against the property. In addition, conditioning loan advances of receipt of lien waivers remains the primary mechanism to ensure that loan proceeds are being properly applied to construction and the loan remains in balance to the costs of completion. Any disclosed liens could be symptomatic of other issues with the borrower or the project and most certainly would trigger a default under the loan documents. However, these issues are business issues and not legal risks that the lender’s first lien position would be imperiled by an unpaid contractor.