Indiana Leasehold Mortgages Governed By Real Estate Foreclosure Statutes, Not The UCC

Indiana’s Remedy For Mechanic’s Lienholder On Property Subject To Mortgage Foreclosure Action

Lesson.  In Indiana lien priority disputes, a purchase money mortgage fares better than a subsequent mechanic’s lien.  Contractors beware. 

Case cite.  Wells Fargo v. Rieth-Riley, 38 N.E.3d 666 (Ind. Ct. App. 2015) .

Legal issue.  As between a mortgagee and a mechanic’s lienholder, whose lien has priority?  And, how does Indiana view each party’s remedy vis a vi the real estate?  Note this case did not involve a construction mortgage (see posts below), which the law treats differently.

Vital facts.  Wells Fargo involved a shopping center.  Lender refinanced the purchase of the subject real estate and held a mortgage, which lender recorded on the real estate in January of 2008.  In 2011, the center’s owner hired contractor to pave the shopping center’s parking lot.  After failing to receive payment, contractor recorded a mechanic’s lien on the real estate.  Neither lender nor contractor got paid, so a foreclosure lawsuit ensued against the center’s owner. 

Procedural history.  The case mainly dealt with the dispute between lender and contractor as to which party’s lien had priority, together with their respective remedies.  The trial court entered a complicated summary judgment spelling out the treatment of the parties’ interests in the real estate.  Lender appealed.

Key rules.  A mortgage takes priority according to the time of its filing.  Ind. Code 32-21-4-1(b).  The effective date of a mechanic’s lien relates back to the date the contractor began work.  I.C. 32-28-3-5.  A mortgage generally takes priority over a mechanic’s lien if the mortgage was recorded before the contractor began its work. 

In instances of a purchase money mortgage, the exception to the general rule arose out of the Provident Bank v. Tri-County Southside Asphalt case decided by the Court of Appeals in 2004 (and discussed in a post below).  That case established that Indiana’s mechanic’s lien statute at I.C. 32-28-3-2 protects contractors by providing priority over a purchase money mortgage “as to the improvement for which he provided the labor and materials.”  Provident Bank went on to hold that the contractor “may sell the improvements to satisfy the lien and remove them” following the sale.  Provident Bank, not unlike Wells Fargo, surrounded paving work (a driveway).  The contractor had a senior lien over the driveway (only) and, as absurd as it seemed, the Court concluded that the contractor could sell and remove the driveway to satisfy its lien. 

Holding.  The Indiana Court of Appeals in Wells Fargo first held that, generally, lender’s mortgage had priority over the contractor’s lien for the simple reason that the lender recorded its mortgage earlier.  Contractor was not entitled to a pro-rata share of the proceeds from the sale of the real estate, as contractor had contended and as other states, such as Illinois, allow. 

The more complicated aspect of the case surrounded contractor’s right to remove and sell the parking lot to satisfy its lien.  Lender asserted that contractor should not be permitted to remove the parking lot because removal would impair the value of the land.  On that issue, the Court remanded the case back to the trial court to determine whether removal of the lot was “practical” and, if so, to allow contractor to exercise its option.  “Otherwise, [contractor’s] lien is junior to [lender’s] mortgage lien, and [contractor] is entitled to proceeds from the sale … only after [lender’s] mortgage has been satisfied.”

Policy/rationale.  Indiana public policy in these cases places the risk of loss on the party best able to avoid the loss.  “A mechanic performing work on property encumbered by a mortgage may easily determine whether the property upon which he will work is encumbered before deciding whether to perform the work.”  Someone has to lose, and Indiana favors lenders.  In my view, the absurdity of the “improvement removal” remedy for contractors serves to force the parties to settle the case. 

Further, I should note that Wells Fargo is a novel decision in that it extends the Provident Bank analysis to mandate a trial court determination of whether removal of the subject improvement is “practical,” which in Wells Fargo meant “that its removal will not substantially impair the value of the land beyond that which it would have been had the parking lot never have been paved.”  Absent a “practical” removal, the mechanic’s lien will be fully primed by the purchase money mortgage. 

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