What Is A “Purchase Money Security Interest”?
Court Recognizes Prepayment Premiums

Blog Post On Priority Of Commercial Construction Mortgages “Affirmed On Appeal”

My July 3, 2007 blog post entitled “Construction Mortgage v. Mechanic’s Lien:  Win, Lose or Draw?” addressed Indiana’s rules applicable to a hypothetical priority dispute between a construction mortgage lender and a contractor in a commercial project.  Based upon my research and analysis at that time, my theory was:

2007: Lender Wins.  At least as to a standard commercial project, therefore, the Ward doctrine of parity seems to be a thing of the past.  The lender, in the scenario presented to me, shouldn’t be forced to share equally with any contractors that started construction before the developer closed the deal.  Instead, the lender should hold a superior lien, assuming the lender records his mortgage before a contractor records a notice of mechanic’s lien.  In other words, if the project goes south, the lender should get paid first.  Having done all the research and reasonably assured myself of the answer to the question, therefore, I believe my lender contact can relax.  Minimal delays with the closing should not adversely affect his bank’s mortgage lien.  But, he should make sure he records the mortgage sooner rather than later, and certainly before any of the contractors record a notice of mechanic’s lien.

This past Wednesday, in a case of first impression in Indiana, the Court of Appeals in McComb & Son v. JPMorgan Chase, Case Number 02A04-0802-CV-60 (McComb.pdf), reached the same conclusion I did.

The situation.  The parties involved in McComb & Son were two general contractors (McComb and ARI), who had entered into a construction agreement with the property owner (Indian Village) to develop an apartment complex.  Lender JPMorgan Chase Bank (Chase) extended an $850,000 line of credit and a $2,650,000 construction loan to Indian Village.  Indian Village failed to pay McComb/ARI and also defaulted on its construction loan with Chase.  Significantly, Chase had recorded its mortgages before McComb/ARI recorded their mechanic’s lien notices.

The statutes.  Indiana law is well-settled that Chase had priority over McComb/ARI with regard to the land and the pre-existing buildings.  The only issue in McComb & Son was whether McComb/ARI had priority as to the improvements they constructed.  The Court outlined the three operative statutes and the corresponding rules/exceptions:   

1.  Generally, a purchase money mortgage is superior to a mechanic’s lien “if the mortgage was recorded before the mechanic’s work was begun or materials furnished.”  Provident Bank v. Tri-County South Side Asphalt, Inc., 804 N.E.2d 161, 163 (Ind. Ct. App. 2004); I.C. § 32-21-4-1(b).

2.  But, a mechanic’s lien holder has priority “as to the improvement for which he provided the labor and materials.”  Provident Bank, 804 N.E.2d at 164; I.C. § 32-28-3-2.  “The holder of a mechanic’s lien may sell the improvements to satisfy the lien and remove them within ninety days of the sale date.”  Thus a mechanic’s lien has priority over a purchase money mortgage with regard to “new improvements” even if the mortgage was recorded before the mechanic’s lien notice was recorded and even if the mortgage was recorded before the mechanic’s lien holder began its work or furnished any materials.

3.  On the other hand, as to commercial property (including apartment complexes), the mortgage of a lender has priority over all liens recorded after the date the mortgage was recorded, “to the extent of the funds actually owed to the lender for the specific project to which the lien rights relate.”  I.C. § 32-28-3-5(d)

For the first time, McComb & Son conclusively tells us what Section 5(d) means.  The Court talked about Ward v. Yarnelle, 91 N.E.7 (Ind. 1910) and its doctrine of parity, as well as the dissenting opinion in the Provident Bank case, both of which I addressed in July of 2007.  According to McComb & Son, the Ward doctrine of parity does not apply to commercial construction projects.  The critical rule announced in McComb & Son was: 

With regard to commercial property, where the funds from the loan secured by the mortgage are for the specific project that gave rise to the mechanic’s lien, the mortgage lien has priority over the mechanic’s lien recorded after the mortgage.

The conclusion.  Chase’s mortgages had priority over McComb/ARI’s mechanic’s liens because:

There is no dispute that [Chase’s] mortgages were recorded before the Lienholders’ mechanic’s liens or that the property in question is commercial in nature.  In addition, the trial court … concluded that the funds from [Chase’s] loan were for the specific project that gave rise to the Lienholders’ mechanic’s liens. 

Although McComb/ARI may seek transfer of the case to the Indiana Supreme Court, for now a lender’s construction mortgage lien will prime a mechanic’s lien, if the lender records its mortgage before any contractor records its notice of mechanic’s lien and if the construction project was commercial in nature. 

The survival of the Provident Bank rule (#2 above).  McComb/ARI argued for application of the Provident Bank rule, but Provident Bank did not involve a construction loan but rather a purchase money mortgage.  As such, I.C. § 32-28-3-5(d) did not apply.  Significantly, however, the Court explicitly stated that I.C. § 32-28-3-2 “still provides the general rule” in cases where the funds from the loan secured by the mortgage were not for the construction of the improvement.