Construction Lending Risks: Protecting a Lender's Lien Priority Over Mechanic's Liens, Stop Notices, and Payment Bonds

Description

Construction lending is rife with many potential risks. The laws governing mechanic's liens vary by state and are often misunderstood. It is imperative that a construction lender determine when a mechanic's lien attaches to the subject property and whether a mechanic's lien is considered superior to other liens in order to take appropriate actions to protect their lien priority.

Lenders can protect their lien priority by leveraging title insurance policies and endorsements to mitigate the risks of mechanic's liens. To avoid gaps in coverage, lenders should require the title company to record the construction mortgage as a first priority lien on the borrower's property and request a "date down endorsement" every time they make a disbursement to ensure that a mechanic's lien hasn't been recorded since the last disbursement.

While mechanic's liens are available in all states, some states like California, Alaska, Arizona, and Washington also allow stop notices, which can be even more problematic to a construction lender. Stop notices allow a subcontractor or supplier to notify the property owner and lender that they are owed money and to withhold a portion of the construction funds until the debt is paid. If a lender has not yet disbursed all the funds from the construction loan and is served with a stop notice, the lender is required to withhold the claimed amount or the lender may be liable for the claim.

Listen as our authoritative panel discusses the lending risks associated with construction loans and provides practical suggestions for mitigating these risks.