Earlier this month, the Pennsylvania Superior Court for the first time issued some very important analysis of the lien priority amendments to the Mechanic's Lien Law in Commerce Bank/Harrisburg, N.A. v. Kessler.
In 2007, the Mechanic's Lien Law was amended. The amendments included revisions to Section 1508, which addresses the priority of contractors' mechanic's liens and liens for construction financing. Under amended Section 1508, in the case of the erection or construction of an improvement, a contractor's mechanic's lien relates back to the date of visible commencement of the work. In other words, the contractor's mechanic's lien claim will take priority over liens filed after the date of visible commencement of the work, even though the mechanic's lien is filed later on during the project.
The Mechanic's Lien Law amendments include some limited exceptions to the contractor's lien priority. The statute provides that a contractor's or subcontractor's lien shall be subordinate to a purchase money mortgage or an open-end mortgage, the proceeds of which are used to pay all or part of the cost of completing erection, construction, alteration or repair of the mortgaged premises.
The recent case of Commerce Bank/Harrisburg, N.A. v. Kessler involved a dispute over these lien priority rules. Michael Ricker was hired by Stephen and Lisa Kessler to build a luxury home in Harrisburg. In October 2006, Ricker started excavation on the Kessler's lot. In January 2007, the Kesslers obtained a construction loan with an open-ended mortgage from Commerce Bank. The mortgage was recorded in the same month. Proceeds from the open-ended mortgage were used to finance construction and to pay off the Kessler's other debts.
The Kesslers subsequently defaulted on both the Commerce Bank mortgage and on their construction contract with Ricker. Commerce Bank foreclosed on the mortgage and scheduled a sheriff's sale. Thereafter, Ricker and Commerce Bank each argued that their respective lien had priority. Ricker argued that his mechanic's lien related back to the October 2006 date of visible commencement of the project. Ricker also argued that the amendments to the Lien Law did not apply because his contract was signed and the construction project began before the Mechanic's Lien Law was amended. Commerce Bank argued that the amendments were retroactive and that Ricker's lien was subordinate to its open-ended mortgage.
On May 9, 2012, the Superior Court found that Ricker's contractor's lien had priority over Commerce Bank's mortgage lien on grounds not before decided by Pennsylvania courts. The Superior Court found that the 2007 Mechanic's Lien Law amendments applied to all liens filed after the effective date of the amendments, regardless of when the construction project began or when the construction contracts were entered into.
The Pennsylvania Superior Court also held that an open-ended mortgage qualifies for the exception and gains priority over contractors/subcontractor's liens only if ALL of the proceeds of the mortgage are used to pay for completing erection, construction, alteration or repair of the mortgaged premises. If even a portion of the loan proceeds are used for non-construction related expenses (i.e. payment of prior mortgages, taxes, other liens, etc.), the open-ended mortgage will not gain priority over the contractor's mechanic's liens.