In today's construction economy, unpaid subcontractors and suppliers with mechanic's lien claims often receive notice that the first mortgage holder is foreclosing on the property. The natural question and assumption by the mechanic's lien holders is "the mortgage company still needs to pay me, right?" Unfortunately, the answer to this question is usually "wrong." If the mortgage holder forecloses and takes over the property, it usually does not need to pay any mechanic's lien claims.
Another common misconception is that the mechanic's lien claimant who files first is paid first; the one who files second is paid second, and so on. This is also generally incorrect. The following is a brief summary of the basic lien priority rules in Minnesota.
Mechanic's Liens Equal Priority
In general, Minnesota is a "first in time, first in right" state. In other words, liens (including mortgages) are ranked based upon the dates they were filed. However, this is not generally true regarding mechanic's liens. All contractors or suppliers with valid mechanic's liens for the same project have equal priority, regardless of the date the liens were filed. This rule makes sense because otherwise it would be unfair to the trades that do not work on the project until its later stages. If the "first in time, first in right" rule applied to mechanic's liens, the excavator's lien would always trump the flooring contractor's lien.
Therefore, if the flooring contractor files its lien within its own time deadlines, it will share equal priority with the excavator or any other valid lien holders. The owner or general contractor may still negotiate separately with the mechanic's lien claimants, but if a closing is set to occur, the mechanic's lien claimant's often need to agree as a group to any payment arrangements or discounts as they are all on equal footing.
Mortgage Foreclosures "First in Time, First in Right"
Because of the "first in time, first in right" rule, the construction lender's mortgage lien is almost always in the first priority position. This means the mortgage holder would be paid before anyone else if the property sells, or if it is foreclosed upon by anyone with a claim against the property. This fact is based upon the assumption that the mortgage is filed prior to the beginning of any construction and before any mechanic's liens are filed.
Therefore, because it is in "first place," if the mortgage holder forecloses upon the property, it is not required to pay the mechanic's liens filed against the property. In such a case, any valid mechanic's liens would only have the right to pay off the mortgage holder at the end of the mortgage foreclosure process (known as "redeeming") and step into the mortgage holder's shoes. The mechanic's lien claimant, or a group of them, would then own the property and need to sell it to recoup the amounts paid to the mortgage holder and attempt to recover payment on the mechanic's lien claims.
While at first glance its might seem unfair that the mortgage holder need not pay the mechanic's lien claimants, consider that the mortgage lender has in essence already paid for the lien claimants' work by loaning funds to the general contractor. However, the general contractor apparently did not use those borrowed funds for their intended purpose. The law provides that it would be unfair to require the mortgage lender to pay again for the labor and materials, and furthermore no lender or bank would ever loan money to a builder if it would at some point be required to pay again when the builder defaults.
In some rare circumstances the mechanic's liens can "trump" the mortgage lien and gain the first priority position. To do so, the mechanic's lien claimants must prove that one of the subcontractors on the project contributed labor or materials to visibly improve the property before the mortgage was filed. The subcontractor who started work before the mortgage was filed does not need to have a valid mechanic's lien, and might have even been paid in full already.
The key is simply that someone started working before the mortgage was recorded. Since construction lenders make it standard practice to photograph the property and confirm that no construction has started before the mortgage is filed, it is rare for mechanic's lien claimants to prevail on a priority claim.
However, if a valid priority claim exists, all valid mechanics's liens "leap frog" the mortgage and will likely be paid. It is often a title company error that leads to a mechanic's lien priority claim (e.g. the title company failed to inspect the property prior to closing, neglected to immediately file the mortgage with the county after the closing, etc.). Mortgage lenders usually purchase title insurance to cover such claims, and if the mechanic's liens can prove priority over the mortgage, the title insurance company will often be forced to pay any valid mechanic's lien claims.
This brief summary touches on only a few commonly questioned areas of lien priorities. The facts and circumstances of each case will obviously vary, and the advice of a construction attorney should be sought when dealing with any actual lien priority situations.
The construction law team at Hellmuth & Johnson, PLLC regularly assists contractors and suppliers with mechanic's lien issues. For additional information, contact Blake Nelson directly at 952-746-2131.