Step Aside Subcontractors, Open-ended Mortgages Take Priority

Legislature clarifies open-ended mortgage priority in response to confusion created by Kessler.

A recent amendment to the Pennsylvania Mechanic’s Lien Law, effective September 7, 2014, clarifies that as long as at least 60% of the proceeds of an open-ended mortgage are intended to pay or are used to pay all or part of the costs of construction, a mechanic’s lien is subordinate to the open-ended mortgage, regardless of whether the open-ended mortgage was obtained from a lender after the commencement of work. A definition of “costs of construction” has also been added as part of the amendment and now specifically includes “soft costs” such as surveys, testing, legal and accounting fees as well as payoffs of existing mortgages and recorded liens.

This change and new definition “shall apply to liens perfected on or after the effective date [September 7, 2014] . . . . .including liens pertaining to the construction of an improvement for which the visible commencement of work occurred prior to the effective date of this section, [September 7, 2014] but were not perfected until on or after the effective date of this section.”

Presumably a result of lobbying efforts by lenders, this amendment is clearly in direct response to the Superior Court decision rendered in Commerce Bank/Harrisburg, N.A. v. Stephen F. Kessler and Lisa K. Kessler in May of 2012 which interpreted section 1508(c) of the mechanics lien law to require that all of the proceeds of an open-end mortgage had to be used to pay for the cost of construction in order to entitle an open-end mortgage to priority over mechanic’s liens. Up to this point, the common practice was to award priority regardless of whether any portion of the loan was also used for “soft costs”.

Amendment to Mechanic’s Lien Law also limits subcontractors’ lien rights

This amendment to the Mechanic’s Lien Law also limits subcontractors’ (including sub-subcontractors) mechanic’s lien rights for improvements made to residential property. Subcontractors can no longer assert a mechanic’s lien if:The owner or tenant paid in full the contract price to the contractor.

1. The property is or is intended to be used as the residence of the owner or subsequent to occupation by the owner, a tenant of the owner; and
2. The residential property is a single townhouse or a building that consists of one or two dwelling units used, intended or designed to be built, used, rented or leased for living purposes.

This amendment gives an owner or tenant the ability to file a petition with the court to strike a subcontractor’s mechanic’s lien in whole if the entire contract price was paid to the general contractor. Moreover, this amendment gives an owner or tenant the ability to file a petition with the court to reduce a subcontractor’s mechanic’s lien claim to the remaining unpaid balance of the contract with the general contractor.