|July 24, 2014|
Previously published on July 18, 2014
A few months ago we published an article titled, “Pennsylvania House and Senate Pass Bills to Ease Construction Lending.” The article described Senate Bill 145 of 2014 which contemplated amendments to the Mechanic’s Lien Law of 1963 authored to ease construction lending. Fortunately, Governor Tom Corbett signed Senate Bill 145 of 2014 into law on July 9, 2014 as Act 117 of 2014. This is welcome news for developers, banks and title companies.
The key provision of Act 117 (“the Act”) is that is gives an open-end mortgage, where at least 60% of the loan proceeds secured by the mortgage are used for “costs of construction”, priority over mechanic’s liens filed after the bank’s mortgage is recorded. This fixes the current problem created by the Pennsylvania Superior Court’s Opinion in Commerce Bank/Harrisburg, N.A. v. Kessler, where the developer already owns the real estate and has started construction before the bank’s mortgage is recorded.
For example, under the law prior to the Act, if a developer purchased real estate, hired an excavator to begin site work, and then, after site work was underway, obtained a construction loan, the mechanic’s lien that would result from the excavator not being paid (and any subsequent, unpaid contractors) would have priority over the bank’s mortgage unless 100% of the proceeds of the loan secured by the open-end mortgage were used for “hard costs”. Many developers will acquire real estate and begin construction using equity prior to obtaining a construction loan, so the Kessler case created a headache for title insurance companies, who were asked to insure the priority of the bank’s mortgage over mechanic’s liens.
Now, under the new provisions of the Act, if, for example, a bank extends a $1,000,000 mortgage to a developer, as little as $600,000 can be used for both hard and soft construction costs and as much as $400,000 can be used to refinance existing debt, and both the bank and title company can have some comfort as to the priority of the mortgage. The Act should ease the anxiety that previously existed for title companies providing mechanic’s liens coverage. Banks should be expected to include specific language in their mortgages regarding use of funds in compliance with the Act, because title companies regularly ask to review the mortgage they are insuring when issuing construction-related endorsements.
Unfortunately, while waiting for the Act to pass, the Title Insurance Rating Bureau of Pennsylvania (TIRBOP) adopted new title insurance endorsements which became effective July 1, 2014. The purpose of the new endorsements is to mitigate the increased risk to title companies resulting from the Kessler case and significantly increases the cost of construction lending. To receive the same coverage which would have been given to an open-end construction mortgage prior to the Act, borrowers will now pay a 20% increase over the applicable non-sale rate. If the bank is willing to accept limited mechanic’s lien coverage (explained below), the borrower will now pay a 10% increase in premium. These increases are in addition to TIRBOP endorsement 1015, which already carries a 10% increase. For example, if a developer obtains a $5,000,000 loan and a corresponding loan policy of title insurance with full mechanic’s lien coverage and common construction-related endorsements, the total increase in premium will be almost $5,000.
The limited mechanic’s lien coverage which carries a 10% premium over the ordinary non-sale rate is offered through a new endorsement, TIRBOP endorsement 1500. This endorsement limits the bank’s coverage to the amount of the loan secured by the mortgage advanced for construction. Each time the bank makes an advance, the bank will be required to receive a date-down endorsement, TIRBOP endorsement 1520, to increase the amount of coverage as a result of the new advance. This endorsement carries a fee each time it is issued. The bank will need to give the title company the advance request and lien waivers signed by the applicable contractors to receive this endorsement.
Hopefully, TIRBOP will now again adjust its rates and policies in light of the Act, but the earliest this can be expected to occur is July 1, 2015. In the meantime, the implementation of the Act is a positive step towards making construction lending easier for all parties involved.