Most construction loans contemplate multiple advances or disbursements of funds at various stages of the construction project. The construction loan agreement will set forth the conditions that the borrower must satisfy to receive each advance of funds. Given that a construction loan concerns an active construction project, there is a risk that a lender could lose its lien priority in an advance (secured by the insured mortgage) to a mechanic’s lien. This post addresses how a title insurance policy and endorsements can insure against such a risk.
This issue arises due to the nature of mechanic’s liens. Specifically, if a contractor does not receive duly owed payment for furnished labor, services or materials, then the contractor may file a lien against the real property for the amount owed (in accordance with state law). In addition, in most states, the priority of the lien typically relates back to the date that the labor, services or materials were initially furnished by the contractor. During construction (and after the title insurance policy is issued), a lender could lose its lien priority in an advance to a mechanic’s lien if the contractor’s work began before the future advance is disbursed.
A lender can insure against such a loss of priority by negotiating with the title insurer to (i) include mechanic’s lien coverage in the title policy jacket or (ii) obtain certain endorsements to the title policy for such coverage. Those familiar with the American Land Title Association (ALTA) forms of titleinsurance policies and endorsements know that the standard covered risks include:
“The lack of priority of the lien of the Insured Mortgage upon the Title (a) as security for each and every advance of proceeds of the loan secured by the Insured Mortgage over any statutory lien for services, labor, or material arising from construction of an improvement or work related to the Land when the improvement or work is either (i) contracted for or commenced on or before Date of Policy; or (ii) contracted for, commenced, or continued after Date of Policy if the construction is financed, in whole or in part, by proceeds of the loan secured by the Insured Mortgage that the Insured has advanced or is obligated on Date of Policy to advance…” (Covered Risk 11(a), ALTA, Loan Policy, Adopted 6-7-06.)
As shown above, Covered Risk 11(a) offers coverage for mechanic’s liens arising before the Date of Policy, or after the Date of Policy if the insured must advance the proceeds under the loan agreement.