Disputes involving the priority between mortgages and construction liens are fact specific and turn on critical issues of timing. In cases decided in early August 2011, the Michigan and Indiana Courts of Appeal decided cases involving priority disputes. The lien claimants prevailed in the Michigan case, and the lender in the Indiana case.

In Jeddo Drywall, Inc. v. Cambridge Investment Group, Inc., - N.W.2d -, 2011 WL 3299812 (Mich. App. 2011), a prior owner of a subdivision site completed clearing, grading, paving and utility work, including work on Lot 204 that was specifically at issue in the case. In March 2005, after the site work was completed, AmTrust Bank (then known as Ohio Savings Bank) loaned the developer $757,500 in exchange for a mortgage against the real estate comprising the subdivision.  In February 2006, a building permit was issued for construction of a home on Lot 204. Stock Building Supply first supplied materials for construction of the home on the date the permit was issued. Jeddo supplied materials in September 2006. Neither Stock nor Jeddo were paid, and they both filed construction liens. AmTrust foreclosed on the development, and lien foreclosure litigation ensued.  

The trial court held that the construction liens had priority over AmTrust’s mortgage because actual physical improvements were made to the real estate before the mortgage was recorded.  The Michigan Court of Appeals affirmed.  Under MCL § 570.1119, a lien relates back in time to the day of the first actual improvement to the property, even if the improvement was not completed by the lien claimant. Here, actual improvements were made to Lot 204 and other parts of the subdivision before AmTrust’s mortgage was recorded. An appraisal prepared for a prior lender stated that improvements were completed as of October 2002, and the AmTrust mortgage itself stated that each single family building site was “fully developed.” Even though the development work was completed by a prior owner, the work related to the same project for which Stock and Jeddo supplied materials in 2006. Moreover, throughout the years the subdivision owners and developers were affiliated by common ownership. The work subject to liens was part of a single project.  Based on these specific facts, the lien claimants had priority over AmTrust’s mortgage.

In the Indiana case, the trial court sided with the construction company lien claimant, but the Bank prevailed on appeal. The real estate at issue was owned by a Trust, which obtained an unsecured $360,000 loan from the Bank in December 2004.  In January 2005 the Bank loaned $2.025 million to Trust, secured by a mortgage. The Bank made another secured loan of $1.775 million in August 2007. The original general contractor for the project recorded a mechanic’s lien, and was paid with proceeds from the January 2005 loan. The construction company, Eby Construction, was hired in November 2006, but was not paid in full. Eby recorded a mechanic’s lien in February 2008, and then filed a foreclosure action.  Eby’s lawsuit was consolidated with another filed by Vendramini Construction, LLC, but shortly thereafter the Trust paid Vendramini with proceeds from the August 2007 loan.

The trial court determined that Eby’s lien should be given priority over the earlier recorded mortgage because the Bank came to the court with “unclean hands,” having been aware of Eby’s lien when it loaned funds needed to pay Vendramini. The Court of Appeals reversed, relying on the interpretation of lien priority statutes in Harold McComb & Son v. JP Morgan Chase Bank, 892 N.E.2d 1255 (Ind. Ct. App. 2008). The Bank’s mortgage (related to the second of the three loans) was recorded before Eby’s mechanic’s lien. Although the Court did not condone the Trust’s decision to pay Vendramini and not Eby, the Bank was not in a position to control the Trust’s decision. The doctrine of “unclean hands,” which provides that a party seeking equitable relief must be free of wrongdoing, did not apply here. Eby knew of the Bank’s mortgage at the time of construction, and was in the best position to avoid a loss. The Trust’s action in paying Vendramini did not put the Bank in a better position because its mortgage always had priority over Eby’s lien rights. In short, this case presented no compelling reason to disregard the statutory priority scheme.