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Commercial Construction Lenders Rejoice: The Pennsylvania Legislature Provides a Statutory fix for the “Kessler” Decision

Real Estate and Finance Alert | July 11, 2014
By: Thomas C. Rogers

In May 2012, the Pennsylvania Superior Court rendered its now infamous “Kessler” decision. The Kessler decision resulted in fundamental changes in the operation of the Pennsylvania Mechanics Lien Act as it applied to construction loans where the visible commencement of work on the project commenced before the recordation of the construction loan’s open-end mortgage.

Essentially, the Kessler decision held that if the visible commence of work on the project began prior to the recording of the open-end mortgage and any loan advances were made other than for what are commonly considered “hard construction” costs, then any unpaid contractors and subcontractors who later filed mechanics’ liens would have their liens take priority over the lien of all of the construction loan advances.

Subsequent to the Kessler decision, both the lending and title insurance communities in Pennsylvania have struggled mightily to structure deals around the problems created by Kessler and to provide lenders with title insurance coverage for construction loans when work commenced before the recordation of the open-end mortgage.

At long last the Pennsylvania Legislature has enacted a much needed statutory fix to the Kessler decision by signing into law Pennsylvania Act 117 of 2014 which amends certain critical portions of the Mechanics’ Lien Act. Act 117 was signed into law on July 9, 2014 and becomes effective on September 7, 2014.

Act 117 amends the Mechanics Lien Act to provide that a construction loan secured by an open-end mortgage under which at least 60% of the proceeds are “intended to pay or used to pay” all or part of the “costs of construction” will have lien priority ahead of any filed mechanics lien claims, even when the visible commencement of work was prior to the recordation of the construction loan’s open-end mortgage.

In the Act 117 amendments to the Mechanics’ Lien Act, the definition of “cost of construction” is critical. The definition is very expansive and includes all costs, expenses and reimbursements pertaining to erection, construction, alteration, repair, mandated off-site improvements, government impact fees and other construction-related costs, including, but not limited to, costs, expenses and reimbursements in the nature of taxes, insurance, bonding, inspections, surveys, testing, permits, legal fees, architect fees, engineering fees, consulting fees, accounting fees, management fees, utility fees, tenant improvements, leasing commissions, payment of prior filed or recorded liens or mortgages, including mechanics’ liens, municipal claims, mortgage origination fees and commissions, finance costs, closing fees, recording fees, title insurance or escrow fees, or any similar or comparable costs, expenses or reimbursements related to an improvements, made or intended to be made, to the property. For purposes of this definition, “reimbursements” includes any such disbursements made to the borrower, any person acting for the benefit or on behalf of the borrower, or to an affiliate of the borrower.

Act 117 provides that the amendments noted above will apply to mechanics’ liens perfected on or after Act 117’s effective date (September 7, 2014), including liens relating to construction of an improvement for which the visible commenced of work occurred prior to Act 117’s effective date but not perfected until on or after that effective date.

This means for existing construction loans where the visible commencement of work began before the recordation of the mortgage…mechanics’ liens on those projects filed on or after September 7, 2014 will not have been priority over the lien of the construction mortgage so long as the 60% test is met. 

For more information, please contact Tom Rogers at 215.864.7190 or rogerst@whiteandwilliams.com.

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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