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Mechanics liens are one of the most powerful tools to protect against the risk of nonpayment on construction projects. But, like with all tools, there are certain situations in which the effectiveness of the mechanics lien may be lessened. Since, in many circumstances, mechanics liens only have priority over other subsequent encumbrances on the property, many lien claimants wonder what happens when a mechanics lien goes up against a pre-existing encumbrance, like a mortgage. This is especially meaningful when the property may not be worth enough to cover all outstanding claims or amounts due, even if secured. When this happens, the liens or encumbrances with the highest priority have the greatest likelihood of getting paid. In a recent case, an Indiana appeals court provided insight into the priority rules for that state.

Case Background

This case stems, as is generally the case, from a payment dispute. It just so happens that there was also the issue of a mortgage foreclosure action, as well. Woodmar Hammond LLC (“Woodmar”) purchased property (“Lot 1”) with $6,200,000 borrowed from Wells Fargo Bank (“Wells Fargo”) pursuant to a first mortgage. On April 30, 2011, the maturity date of the loan, Woodman defaulted by failing to pay the principal amount due.

In November and December of 2011, Woodward hired Rieth-Riley Construction Company, Inc. (“Rieth-Riley”) to perform paving services at a cost of $251,800. Woodward failed to pay the amount due to Rieth-Riley, and as a result, Rieth-Riley filed a mechanics lien against the property. Both Wells Fargo and Rieth-Riley attempted to foreclose on the property to recover payment, and both claimed priority.

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The general rule for priority of encumbrances of real property in Indiana is set forth by Indiana Code section 32-21-4-1(b), which provides that:

“[a] conveyance, mortgage, memorandum of lease, or lease takes priority according to the time of its filing.”

Since Wells Fargo recorded its mortgage in 2008, and Reith-Riley recorded it’s mechanics lien in 2012, it would seem that the issue of priority would be clear in this case, to the detriment of the mechanics lien claimant. While mechanics lien priority relates back to the “date the mechanic or other person began to perform the labor or furnish the materials or machinery.” I.C. § 32-28-3-5, that still doesn’t appear to help Rieth-Riley in this case, since the work was initiated more than 3 years after Welss Fargo recorded the mortgage. However, this is not the end of the story.

Indiana law provides that a mechanics lien attaches on the improved structure and the land on which it sits. Specifically, Indiana Code section 32-28-3-2 states that:

(a) The entire land upon which the building, erection, or other improvement is situated, including the part of the land not occupied by the building, erection, or improvement, is subject to the lien to the extent of the right, title, and interest of the owner for whose immediate use or benefit the labor was done or material furnished.

(b) If: (1) the owner has only a leasehold interest; or (2) the land is encumbered by mortgage;

the lien, so far as concerns the buildings erected by the lienholder, is not impaired by the forfeiture of the lease for rent or foreclosure of mortgage. The buildings may be sold to satisfy the lien and may be removed not later than ninety (90) days after the sale by the purchaser.

Indiana courts have interpreted the statute to protect the mechanics lien claimant’s priority as to the specific improvement made to the property, by stating that the lien claimant can sell the improvements to satisfy the lien and remove them within ninety days of the sale date. This seems to favor the mechanics lien claimant as to new improvements even if there was a subsequently recorded mortgage or other encumbrance.

So, in the case at issue, the appeals court noted that Reith-Riley had priority as to the improvement itself (the paved parking lot), and could assert that priority by selling and removing the parking lot, and is not – as the trial court apparently determined – without priority but entitled to a pro rata share of the proceeds from the sale of the whole property pursuant to the mortgage foreclosure.

As a practical matter, removing and selling a parking lot may be a difficult proposition, but that is the remedy set forth by the statute. However, Rieth-Riley noted that the asphalt could be reclaimed from the lot and re-sold. To that end, the court determined that “to the extent that removal of the parking lot is practical—meaning that its removal will not substantially impair the value of the land beyond that which it would have been had the parking lot never been paved—we believe it falls within the category of things that Indiana Code section 32-28-3-2 allows to be removed to satisfy a mechanic’s lien”. And accordingly, Reith-Riley had priority over the parking lot improvement itself, and Wells-Fargo had priority over the land.

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Indiana Sheds Some Light on Mechanics Lien Priority
A recent Indiana case provides welcome insight with respect to mechanics lien priority related to prior encumbrances. Here's what you need to know.
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