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#42:  Mechanic's Lienor vs. Mortgagee: Who Has Priority?

4/26/2016

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Sorting out the “priority” of creditor claims against a piece of real estate―the pecking order when the asset is sold―can occasionally be a thorny task.  Whether the creditor’s claim is secured with the owner’s consent (i.e., mortgages) or without it (e.g., court-ordered attachments, tax liens, condominium assessment liens, commercial real estate broker liens), in all cases some instrument must be recorded at the registry of deeds―and it would be a simple matter for the law to declare that in all cases the order of recording establishes priority.  That is indeed the general rule; see RSA 477:3-a, providing that any “instrument which affects title to any interest in real estate” must be recorded and “shall not be effective as against bona fide purchasers for value until so recorded.”  But there are some exceptions which allow a later-recorded interest to achieve priority over an earlier-recorded one.
 
In determining whether mechanic’s liens are such an exception, RSA 447:9 is the starting point: “The lien created by RSA 447:2-7, inclusive, shall continue for 120 days after the services are performed, or the materials, supplies or other things are furnished, unless payment therefor is previously made, and shall take precedence of all prior claims except liens on account of taxes.”  On first blush, this appears to declare that a mechanic’s lien always trumps an earlier-recorded mortgage.  But appearances can be deceiving.

Consider RSA 479:3, which provides: “Subject to the provisions on priority in RSA 447:12-a, a recorded mortgage takes priority as of the date of its recording as to advances or obligations thereafter made or incurred that do not exceed the maximum amount stated in the mortgage.”  With exceptions found in RSA 447:12-a (I’ll deal with that statute in a moment), RSA 479:3 thus allows a mortgage recorded on Day 1 to retain whatever priority it may have over any interest recorded on Day 2 even as to mortgage advances made on Day 3.  Standing alone, this says nothing about relative priorities between the Day 1 and Day 2 recordings.  But Earnshaw v. First Federal Savings and Loan Association, 109 N.H. 283 (1969), does.  Construing an earlier version of RSA 479:3 (before enactment of RSA 447:12-a), the Court ruled that a construction loan mortgage had priority over a later-recorded mechanic's lien, even as to advances made after the lien attached.

With a few exceptions, RSA 447:12-a provides that a mechanic’s lien “shall have precedence and priority over any construction mortgage.”  Before concluding that this is just a redundancy given RSA 447:9, it would be well to consider our Supreme Court’s statement that “without RSA 447:12-a (Supp. 1975) prior law would have given the construction mortgage of defendant priority over Sullivan's mechanic's lien,” L. M. Sullivan Co., Inc. v. Essex Broadway Savings Bank, 117 N.H. 985 (1977).  Even more telling is Lewis v. Shawmut Bank, N.A., 139 N.H. 50, 52 (1994), which allowed a mortgage to trump a mechanic’s lien as to the portion of the mortgage loan that was not for construction purposes: “The statute only provides priority over prior mortgages based on construction loans. Therefore, if the defendant's loan is regarded as a ‘mixed’ loan (i.e., its purpose is to finance not only construction, but also land acquisition or discharge of mortgages on land), then, under the race-notice rule of priority, the defendant would enjoy priority with respect to non-construction disbursements.”

As I said, appearances can be deceiving.  RSA 447:9’s “shall take precedence of all prior claims” does not include prior mortgages.  Priority as between a mechanic’s lien and a construction mortgage is determined by RSA 447:12-a.  But priority as between a mechanic’s lien and a conventional mortgage is determined by the general first-to-file rule.  If RSA 447:9 was the Legislature’s effort to give mechanic’s liens priority over earlier mortgages, it forgot about 477:3-a, thus leaving to the courts the task of resolving inconsistent statutes.  And the courts have come down in favor of the mortgage holder―who would be no worse off if priority were given to a subsequent mechanic’s lien for labor and materials that added value to the real estate equal to the amount of the lien.  A rising tide lifts all boats.

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#41:  Contractor vs. Mortgagee: Who Gets the Insurance Proceeds?

4/2/2016

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An insured building is damaged by fire or other casualty.  The owner files an insurance claim and hires a contractor to make repairs, promising to use the insurance proceeds for that purpose.  The contractor does the work before the insurance proceeds are received.  When the insurance check arrives, it is payable to both the owner and the owner’s mortgage lender – who refuses to allow it to be disbursed to pay the contractor despite the pleas of the owner.  When the owner can’t pay him, the contractor puts a mechanic’s lien on the property – and sues both the owner for breach of contract and the mortgage company for “unjust enrichment,” “constructive trust” and a host of other legal theories they teach in law school.  Who wins?
 
Because a property and casualty insurance policy is personal to the policyholder and does not run with the insured property, a mortgage holder is not entitled to insurance proceeds simply because of its mortgage on the insured property.  The mortgagee does, however, have an "insurable interest" in the property (i.e., something of value to protect, without which the law regards an insurance policy as an illegal gambling contract), and it is common for mortgages to require mortgagors to obtain casualty insurance on the property payable to the mortgagee as “loss payee.”  
 
This same principle of personal contract rights as opposed to rights running with the land means that lien priorities with respect to the property do not determine the priority of competing claims to insurance proceeds.  See, e.g., Midland Lumber & Supply, Inc. v. J.P. Builders, 265 N.J.Super. 246, 626 A.2d 89, 91 (1993) (“Because of the personal nature of a contract of insurance, if an insurance policy is made expressly payable to a second mortgagee, the second mortgagee is entitled to the policy proceeds in preference to the holder of a first mortgage who is not listed as a loss payee under the policy.”).  Thus, resolving whether the mechanic’s lien or the mortgage has first dibs against the property won't determine who has first dibs on the insurance proceeds. 
 
Even though the insurance check is made payable to the mortgagee, the nature of insurance can tip the scales here.  Property insurance contracts are contracts of indemnity, and to the extent they result in a monetary benefit beyond reimbursement for the peril insured against – which is what happens once repairs have been made but aren’t paid for – they are pure windfalls.  A Maryland case, Cottman Co. v. Continental Trust Co., 169 Md. 595, 601-02, 182 A. 551 (1936), explains:
 
“It cannot be denied that if the restoration of the security, at the expense of the debtor, to the value it had before the loss or damage, leaves the parties in statu quo, then the retention of the insurance money by the creditor, mortgagee, or trustee, as additional security, would put the holder in a better position than he had originally bargained for. The theory of insurance, however, does not contemplate a resulting profit to the insured, or his mortgagee or other creditor. The interest of the mortgagee is to maintain the equilibrium of debt and security; and if, by the application of the insurance money to the upkeep of the security, that parity would be continued, it is not inequitable to require the payee of the fund to transfer the same to the debtor for that purpose, upon properly safeguarding its application to that end.”
 
If our courts take this approach, the mortgagee in our hypothetical has indeed been unjustly enriched contrary to the purposes of insurance, and should be required to hold the proceeds for the benefit of the contractor rather than apply them to the mortgage indebtedness.  There is every reason to think that our courts would require exactly that.  “An equitable lien may be imposed to prevent unjust enrichment in an owner whose property was improved, for the increased value of the property.”  Iacomini v. Liberty Mutual Ins. Co., 127 N.H. 73, 78 (1985).  It is no stretch at all to deem the mortgagee to be the “owner” for such purposes.
 
Who wins?  Bet on the contractor.

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    Frank Spinella

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