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#77:  Mechanic's Lien vs. Mortgage: A Quirk in the Priority Scheme

5/26/2019

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A few years back I blogged (#42) on priorities as between mechanic’s liens and earlier-filed construction mortgages (the mechanic’s lien wins, subject to a couple of exceptions), and as between mechanic’s liens and earlier-filed conventional mortgages (the conventional mortgage wins).  This priority scheme raises the possibility that the priorities may not be transitive: A could trump B, B could trump C and C could trump A if a construction mortgage is recorded first, a conventional mortgage is recorded second and a mechanic’s lien is recorded third.  In such a case, what will be the pecking order after a foreclosure?

Recently the New Hampshire Supreme Court rendered an opinion on a somewhat analogous fact pattern that may shed light on our question.  In Sabato v. Federal National Mortgage Association, 172 N.H. 128 (2019), the plaintiff’s wife gave two mortgages on her home to two different mortgagees, but the plaintiff waived his $120,000 homestead exemption – which trumps a mortgage if not waived, see RSA 480:5-a – only as to the second mortgage.  When the second mortgagee foreclosed and bought the property at auction for $64,872 subject to the first mortgage, the question arose whether the homestead exemption had been extinguished by the foreclosure even as to the first mortgage.  “The plaintiff contended that foreclosure of the second mortgage did not affect his homestead right because he had not waived that right in the first mortgage.  FNMA argued that, because the plaintiff waived his homestead interest in the second mortgage, he could not now assert any homestead right.”  Id. at 130.

Both positions were rejected.  Noting that “upon foreclosure, the plaintiff’s homestead right had priority over the first mortgage,” the Court ruled “the waiver gave [the] second mortgage priority over the first mortgage up to the value of the plaintiff’s homestead right ($120,000),” meaning that when it “foreclosed its second mortgage, it stepped into first position up to a maximum of $120,000 because it, unlike the first mortgagee, had access to the value of the homestead right, and that right, as previously noted, had priority over the first mortgage.”  Id. at 133.  Since the $64,872 bid at the foreclosure sale was the second mortgage balance, there was no surplus to deal with, but the Court nevertheless said this: “Had the property sold for more than the indebtedness under the second mortgage note, the surplus proceeds up to the remaining balance of the plaintiff’s homestead exemption would have been exempt from the first mortgage and payable to the plaintiff before FNMA, as holder of the first mortgage, received any proceeds.”  Id. at 134.

The Court then addressed the extent to which the homestead exemption had been extinguished by the foreclosure, ruling that “any portion of the exemption left after satisfying the second mortgage, which continues to exist in either the surplus [citation omitted] or, we now hold, in the property, is not subordinate to the mortgage and is not extinguished by the foreclosure. . . The waiver of the plaintiff’s homestead exemption in the second mortgage did not impute a waiver into the first mortgage; rather, the waiver in the second mortgage merely gave the second mortgagee the right to step into the plaintiff’s shoes with respect to his priority over the first mortgage up to the value of the homestead exemption . . . The plaintiff, having waived his homestead right in the second mortgage, has no grounds to complain that the second mortgagee has availed itself of the homestead to satisfy its mortgage and left him unable to assert his entire homestead exemption against the first mortgagee.”  Id. at 135.

The analogy between a homestead exemption and a mechanic’s lien is not perfect, but Sabato suggests that a mechanic’s lien with priority over a first mortgage but not over a foreclosing second mortgage will be extinguished by the second mortgagee’s foreclosure only to the extent necessary to satisfy the second mortgage balance.  A sales price at foreclosure above that amount will likely be deemed to create a fund on which the mechanic’s lienor has first dibs.  To be safe, the lienor may need to bid at auction a price sufficient to cover not only the second mortgage balance but the lien amount as well.

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    Frank Spinella

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