If a construction project gets saddled with mechanics lien claims and money gets tight, the topic of “Lien Priority” can suddenly become very important. Every state has some method of ranking lien and paying lien claims. These methods typically not only pit mechanics lien claimants against one another, but also against lenders who contribute funds to the project.

New York’s lien priority rules are spelled out in its statutes, but a recent Court of Appeals decision closely analyzing Lien Law § 22 indicates that priority may not always be so clear.

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New York Lien Law § 22 and Lien Priority

When a construction lender contributes funding to a construction project in New York, Lien Law § 22 applies to determine whether the lender’s claim against the property has priority over any filed mechanics lien claims. The statute itself is a complete nightmare to read – go ahead, give it a shot:  New York Lien Law Section 22.

Simply speaking, the statute sets forth a “first to file” type rule, whereby priority is provided to the claim that is filed first.  If a construction lender follows the statute and files the proper paperwork when the loan closes, and mechanics lien claims are filed thereafter, the lender’s lien will outrank the lien claimants. Otherwise, however, the mechanics lien claims will outrank the lender’s lien.

There are two things to keep in mind as we discuss this statute and the recent New York case addressing the same.

First, this ranking rule only applies to “building loan contracts.”  Lien Law §2(13) defines this term as: “a contract whereby [a lender], in consideration of the express promise of an owner to make an improvement upon real property, agrees to make advances to or for the account of such owner to be secured by a mortgage on such real property.”  The Section makes building loan contracts subordinate to mechanics lien claims if certain requirements are not met, but the same rule does not apply to standard mortgages.

Second, there are plenty of circumstances that arise whereby construction loans are made after construction begins on a project. This occurs when projects need to be refinanced, or when they need additional sums to get the job completed.

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As we’ll see from the case discussed in the next section, although the general rule is “first to file,” the rule is complicated and full compliance is critical.

Recent Decision Makes Compliance With §22 Critical for Lenders; Good News For Claimants

A few months ago we wrote about a case in New York finding that the lender had complied with §22, and therefore, was entitled to priority over mechanics lien claims on the project.  In our discussion of the case, Adams v. Carriage House Farms, we sounded this warning:

Rule 22 is complex and still open to interpretation such that a lender may not comply with its strict requirements every time.

Less than 3 months after publishing this statement, New York’s Court of Appeals issued what Vincent Pallaci called “Rare Commentary on Section 22 of the Lien Law and Priority,” explaining the details of § 22’s requirements and how strictly a lender must comply with the statute to get claim priority.

There was a loan that met the definition of a “building loan contract,” and accordingly, the lenders had to file it and any modifications in strict accordance with §22. Failing to do that, the building loan contract was subordinate to mechanics lien claims.  In the case, Altshuler Shaham Provident Funds v. GML Tower, the lender sought priority arguing: (i) That the loan in question was not a “building loan contract;” and (ii) That priority was preserved according to §22.

To the first question the Court of Appeals simply called a spade a spade. As Pallaci writes in his excellent post on this case, the court found that the agreement “had all the tell-tale characteristics of a building loan contract.”

To the second question the Court of Appeals found that the lender did not strictly comply with §22’s filing requirements. This finding turned on a technical analysis of the loan timeline and contents. The lenders had issued some money for construction and some money for acquiring the property, and this division of proceeds was further complicated by timing because an original loan was issued and was followed by a modification.

The Court of Appeals rejected the lenders attempt to skirt around §22 by arguing about how the loans and their modifications should be classified. There was a loan that met the definition of a “building loan contract,” and accordingly, the lenders had to file it and any modifications in strict accordance with §22.  Failing to do that, the building loan contract was subordinate to mechanics lien claims.