Whenever a property owner goes into financial trouble, mechanics lien claimants naturally wonder if they can still get paid. This often comes down to determining where the mechanics lien ranks on the lien priority ladder.
Unfortunately, the answer is far from simple. One may think that whatever assets the property owner still has could be divided evenly and proportionally to whoever was still owed money, but the law dictates that some parties have priority over others. In the legal world, priority means that one party is entitled to have all of its debts paid off before anyone else has a shot at the money. Where mechanics liens rank on the relative priority ladder is addressed in each state’s FAQ section, here. In Louisiana, one common example is that in a foreclosure action, the IRS is entitled to any back property taxes before a bank is entitled to have its loan paid off. In most states, governmental tax liens and first mortgages generally have priority over other liens attached to the property.
Mechanics Lien Priority: Do They Always “Rise to the Top of the Class” in New York?
Construction Payment Blog has addressed how a mechanics lien is a powerful tool to get subcontractors or suppliers paid many times. One court has even noted that mechanics liens “rise to the top of the class” above all other unpaid parties, including other lien claimants.
New York law is a bit more convoluted in this situation. Essentially, if a property owner runs out of money or a property is foreclosed on, the relative priority of mortgage holders and mechanics lien claimants can shift. Generally, the bank who made the loan has first priority, but sometimes, unpaid subcontractors or suppliers have first priority if the mortgage lender failed to comply with the applicable rules. The issue of who gets first dibs at whatever assets are left comes down to the application of “Rule 22,” or NY LIEN § 22. Generally, the rule outlines what is a fairly standard rule in determining lien priority: first-in-time, first-in-right. That is, a mortgage that was recorded prior to the filing of a mechanics lien will have priority over the subsequent lien.
So long as a lender complies with the statutory requirements applicable to the loan contract – such as meeting the requirements of having the contract in writing and filing it with the clerk in the county where the property is situated – that lender’s mortgage takes priority over any mechanics liens that may subsequently be filed against the property.
New York Lien Law Rule 22 in Action
In a recent case, Adams v. Carriage House Farms, a New York appeals court affirmed the lower court’s finding that since the lender complied with all the requirements of Rule 22, the lender was entitled to be paid first over an unpaid subcontractor who had filed a lien on the property and was suing to foreclose on it. The court held that the mortgage lien, under the facts described in the case, should be satisfied first over the mechanics lien.
Of course, the unpaid subcontractor probably wasn’t too happy with the appeals court’s decision. But there are still two take-aways of which New York subcontractors should be aware.
- First, just because a mortgage lien may take priority over a mechanics lien doesn’t mean there’s no point in even filing a lien; whatever funds leftover in the property will go directly to the subcontractor because of the power of a lien.
- Second, Rule 22 is complex and still open to interpretation such that a lender may not comply with its strict requirements every time.
In other words, even when a mortgage company and unpaid subcontractor have competing interests in a property, if the lender misses one tiny part of the law, the subcontractor will be able to prove in court that it is entitled to first dibs in any assets the property owner still holds. And, in any event, the lien priority of the mortgage lien only applies to the balance of the mortgage. While that may be a significant portion of the foreclosure price of the property (especially recently), if the property owner has paid down the mortgage balance over a period of many years, or paid a large down-payment to reduce the necessary mortgage, there are more funds to go around to mechanics lien claimants – at the expense of unsecured creditors.