By John Hickey
In the past year a record number of properties have gone into foreclosure. Many experts believe that because of the slowing economy and falling housing prices, the high rate of foreclosures will continue for the foreseeable future. Thus it is important for those in the construction industry to know what effect a foreclosure will have on construction liens.
A construction lien, created under Chapter 87 of the Oregon Revised Statutes, protects the right of contractors, subcontractors, laborers, suppliers of materials or equipment, and design professionals to be paid for their work. Properly perfected, a lien allows the holder to force the sale of the property and to be paid from the proceeds. But in most cases, there is also at least one mortgage on the property. What happens to the construction lien when the property owner defaults on the mortgage and the bank forecloses? The answer to that question depends on whether the lien has "priority" over the mortgage. Having priority means that the lien must be paid first if a bank forecloses on its mortgage.
A contractor who prepares a property for construction or improves a road next to the property has a lien on the property itself. Landscape architects and surveyors who assist in preparation of the property also have liens on the property. If a mortgage was not recorded before construction began or before materials were delivered, those construction liens will have priority over that mortgage.
If the mortgage was recorded before construction began, a construction lien might still have priority. Contractors who provide labor and materials for the construction of improvements on property have a lien on the improvement, and the improvements may be sold separately from the land to enforce the lien. If a mortgage was recorded to secure the construction loan used by the property owner to pay for construction, then construction liens perfected by contractors and subcontractors will have priority over that mortgage, even if the mortgage was recorded before construction began. But the priority exists only as to improvements that may be removed without reducing the value of the property below the property's value when the mortgage was recorded.
No lien for materials or supplies has priority over a mortgage that was already recorded when construction began, unless notice was given to the mortgage holder, usually a bank. The material supplier must give the bank notice within eight days (not including weekends and holidays) after delivery of the materials or supplies. The notice must be the same as the "claim of lien" notice that must be given to the property owner. If the proper notice is given, a lien for materials or supplies also has priority over a mortgage that secures the construction loan.
If the mortgage was before construction began but does not secure a construction loan, then the mortgage has priority over a construction lien — for example, when the mortgage secures the loan to purchase the property but the property owner is paying for the improvements out of pocket.
A buyer purchases a property free of all liens; thus, when a mortgage has priority over a construction lien, foreclosure of the mortgage eliminates the construction lien.
It is always important for people or companies with lien rights to provide all required notices and properly perfect their liens; otherwise they may be left with an invalid and unenforceable lien. But in many cases, even if everything is done correctly, mortgages on the property will have priority.
In limited circumstances, a construction lien holder — without priority over a mortgage — may still be protected if the mortgage is foreclosed. The statutes that govern construction liens allow property owners to remove liens from their property by filing a bond. When a bond is filed the lien is removed from the property or improvement and attaches to the bond. Many mortgages contain language that requires property owners to remove any liens against property by filing a bond. If the mortgage is foreclosed after a bond is filed, the construction lien may still be foreclosed against the bond. Thus, the construction lien holder is protected, even if the mortgage has priority.
If it appears that the property owner on a project you are working on is not paying on its mortgage, it is extremely important to talk to your attorney to determine whether your lien has priority over the mortgage and to take steps to protect your right to payment if foreclosure occurs. Times like these require caution and foresight.