Harmon & Davies, P.C.

In 2012 the Superior Court of Pennsylvania, in the matter of Commerce Bank/Harrisburg, N.A. v. Kessler et al., ruled in favor of a general contractor by finding that the general contractor’s mechanics’ lien had priority over the mortgagee’s lien.  For those outside the construction industry this might not be titillating news, but for members of the industry (and their lawyers) who rely on mechanics’ liens to ensure payment, the holding is welcome news.

The story starts in October 2006 when the general contractor contracted with a couple to build them a luxury home in Harrisburg.  Shortly thereafter, the GC started excavating.  A few months later, in January 2007, the couple got a construction loan from what is now Metro Bank for up to $435,000, which loan was secured by an open-ended mortgage that was recorded that same month.

The home was substantially complete in August 2007.  Unfortunately, the couple was unable to make their mortgage payments and Metro Bank filed a mortgage foreclosure action against the couple and obtained a default judgment against them for $403,994.84 in July 2008.  The couple also failed to make their payments to the general contractor and the general contractor obtained a default judgment against the couple in the amount of $411,304.14 in February 2009.

Thereafter, Metro Bank and the general contractor became entangled in a legal battle over which judgment took priority, in other words, there was a dispute over which party was first in line to collect the proceeds from the sale of the home.  The trial court entered an order holding that the judgment entered in favor of the general contractor took priority over the judgment entered in favor of Metro Bank.  Metro Bank appealed.

Under the 2007 amendments to Pennsylvania’s Mechanics’ Lien Law, Section 1508(c) awards priority to a mortgage over a mechanics’ lien where the mortgage constitutes:

(2) An open-end mortgage as defined in 42 Pa.C.S. 8143(f) (relating to open-end mortgages), the proceeds of which are used to pay all or part of the cost of completing erection, construction, alteration or repair of the mortgaged premises secured by the open-end mortgage.

49 Pa.C.S.A. 1508(c)(2) (emphasis added).  Metro Bank took the position that this section of the Mechanics’ Lien Law gave its mortgage priority over the general contractor’s mechanics’ lien, but the general contractor argued that the open-end mortgage upon which Metro Bank based its lien did not satisfy the requirements of Section 1508.

Indeed, it was undisputed that a portion of the proceeds of the open-end mortgage in this matter paid for expenses other than “completing erection, construction, alteration or repair of the mortgaged premises.”  Rather, some of the proceeds were used to pay costs such as tax claims, closing costs, satisfaction of an existing mortgage on the property, and payment of other judgments and liens.  The general contractor argued that to allow use of funds for reasons other than those expressly set forth in Section 1508(c)(2) would, for example, permit a lender and owner to defeat a contractor’s lien rights by using as little as $1.00 out of $1,000,000.00 for the enumerated purposes set forth in Section 1508(c)(2) and therefore Metro Bank could not rely on Section 1508(c)(2) to subordinate the general contractors mechanics’ lien on the property.

The Superior Court of Pennsylvania agreed with the general contractor finding that Section 1508(c)(2) only extends priority to mortgage loans where the proceeds were used to pay the expenses set forth in Section 1508(c)(2).  The court interpreted the use of the term “the proceeds” to mean all of the proceeds and agreed with the general contractor that any other interpretation of the statute would permit lenders and owners to improperly manipulate the system to defeat lien rights

In ruling in favor of the general contractor, the court also disagreed with Metro Bank’s contention that the mechanics’ lien was invalid on the basis that it allegedly failed to contain the statutorily mandated statement of the kind and nature of materials furnished.  Although the general contractor’s lien claim described the kind and character of the work as “all labor and materials required for the construction of a two story residential dwelling” and referred to the construction contract, Metro Bank argued that because the lien claim failed to attach the drawings and specifications referenced in the contract, the statement of the kind and character of the labor and materials furnished was too vague.  As such, Metro Bank asserted that the mechanics’ lien was invalid.

The general contractor argued that his lien was not invalid because he substantially complied with the requirements of the Mechanics’ Lien Law.  Again, the court agreed with the general contractor noting that multiple Pennsylvania cases interpreting the “contents of the claim” section of the Mechanics’ Lien Law have long held that “in considering a mechanics’ lien claim, it must be kept in mind that substantial compliance with the Act is sufficient” and that the express terms of Section 1503((5) only required a general statement of the kind and character of the labor and materials furnished.  Accordingly the court held that the lien claim sufficiency described the nature of materials furnished.

Lesson Learned:  If all the proceeds of a mortgage were not applied to the cost of completing erection, construction, alteration or repair of the mortgaged premises, a contractor’s mechanics’ lien claim should take priority over the lien of a mortgagee.  Of course, these things can vary depending on the circumstances of an individual case and it is highly recommended that a general contractor consult with a lawyer to ensure that its lien rights are protected to the maximum extent possible.

This article is authored by attorney Shannon O. Young and is intended for educational purposes and to give you general information and a general understanding of the law only, not to provide specific legal advice. Any particular questions should be directed to your legal counsel or, if you do not have one, please feel free to contact us.

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