Does your construction mortgage really protect you from mechanic’s liens?

If you are a lender/mortgagee and your borrower/mortgagor is adding more real property collateral to the mortgage (in Ohio), how do you retain your first priority position in all mortgaged property while adding that property to the mortgage? This question is especially relevant when the borrower is assembling property as part of a development. The answer may not be as simple as you think.

You could do an amended and restated mortgage, but that could be construed as replacing the original mortgage, which would cause the priority of the mortgage to be changed from the recording date of the original mortgage to the recording date the amended and restated mortgage. So, instead you could record an amendment or modification which adds property to the mortgage. Naturally you would include a provision that states that all of the original mortgage provisions continue in full force and effect. That should do it, right? Well, recently one Ohio Court said “no.”

In 2003, Bridgeview Crossing LLC (“BC”) began assembling properties for a commercial development. In 2006 BC signed a $24,000,000 Cognovit Note and granted an open-end construction mortgage (the “Original Mortgage”) in favor of its lender (the “Mortgagee”). There was evidence that Panzica Construction Company (“Panzica”) had done some work before the mortgage was recorded (and before the Notice of Commencement was recorded).

Normally, a subsequently filed mechanics lien for work done before the Original Mortgage was filed would have priority over the mortgage. (See Ohio Revised Code § 1311.13.) However, the Original Mortgage contained the standard construction mortgage provision contained in Ohio Rev. Code 1311.14, which, if the requirements are satisfied, gives a construction mortgage “super-priority” over mechanic’s liens which are later filed for work done prior to the filing of the mortgage.

After the Original Mortgage was filed, BC continued to acquire more properties. The Mortgagee wanted to add those properties to the Original Mortgage and maintain the same “super-priority” over subsequently-filed mechanics liens. This was done by recording a series of Mortgage Modifications (individually a “Modification” and collectively, the “Modifications”) adding more property to the lien of the Original Mortgage, which were recorded from December 22, 2006 through May 13, 2008. Each Modification included the following language (the “Reaffirmation Clause”): “Except as amended and modified hereby, the provisions of the Loan Documents remain in full force and effect and are binding upon and shall inure to the benefit of the parties hereto and their respective heirs, personal representatives, successors and assigns.”

On October 15, 2008 Panzica filed a mechanics lien affidavit (amended December 12, 2008), claiming that it had started construction work prior to the date of filing of the Original Mortgage. In late 2008 BC defaulted on the loan and the Mortgagee took judgment on the Cognovit Note, but did not foreclose.

In August 2009 Panzica filed a foreclosure action (Cuyahoga County Common Pleas Court Case No. 09 CV 700759) and subsequently claimed that it had priority over the Mortgagee’s interest in the collateral. In late 2012, the Mortgagee and the Panzica both filed motions for summary judgment. The facts were complicated and many legal issues were raised. On September 24, 2014, the Court issued its ruling.

The Court held that since the Modifications did not include a recitation of the 1311.14 statutory construction loan language, that the “super-priority” law did not apply to the property added to the Original Mortgage. The Court then ruled that Panzica’s mechanics lien had priority over the Original Mortgage with respect to the properties added via the Modifications. The Mortgagee’s priority over the various property parcels would be based on the date the respective Modifications were recorded. The Court did not address the efficacy of the Reaffirmation Clauses in the Modifications or any of the other issues raised in the summary judgment motions. On October 22, 2014, the Mortgagee filed a notice of appeal, which appeal remains pending.

You may scoff at this ruling, assured that it does not apply to you because if you were going to add additional land to your mortgage, you would get a lien waiver and title insurance. Well, the Mortgagee here did those things, but Panzica argued that the lien waivers were ineffective. Furthermore, the Mortgagee obtained title insurance guarantying the Modifications were first priority. Unfortunately the ruling did not discuss the lien waiver issue or any other issues raised in the motions. Moreover, the title insurance covers any eventually proved loss, but it does not speed up the foreclosure process itself. This foreclosure has been pending for five years and the appeals are likely to last for years longer. As a result, the property will remain in limbo and remain undeveloped for a long time without generating any income and without any productive use.

So, faced with this ruling, what should mortgagees do to protect themselves in these situations? Of course, there is no definitive answer. It appears that the Panzica case judge wants you to specifically include in your amendment or modification, the 1311.14 construction mortgage language. But if you do that and do not include other provisions of the original mortgage, you might be faced with the claim that the amendment did not include all other terms of the original mortgage and therefore those provisions do not apply to any property or debt added to the original mortgage with the amendment. Finally, as stated above, if you do an amended and restated mortgage you could lose your original priority date.

Perhaps for now, until the Court of Appeals sorts this out, the best compromise is to add the following clause to any amendment: “All of the terms of the Original Mortgage remain in place and are incorporated hereat by reference, including but not limited to the provision in the Original Mortgage that states that it is a Construction Mortgage pursuant to Ohio Revised Code Section 1311.14.” Additionally it would be prudent for all original mortgages to include a provision that states that any and all future amendments or modifications to the mortgage shall be governed by the provisions of said mortgage, except as otherwise set forth in such amendments or modifications.

Just when you thought you had enough belt and suspenders language, you find out that you need to think again.