Illinois Supreme Court Finds Lenders Entitled to Pro Rata Participation in Value of Construction Improvements Upon Foreclosure
On February 25, 2011, the Illinois Supreme Court provided lenders further comfort concerning construction lending and the sometimes confusing interplay between mortgage and mechanics liens. In LaSalle Bank National Association v. Cypress Creek 1, LP, the Court addressed the appropriate method of distribution of foreclosure sale proceeds between a mortgagee-Bank and mechanics lien claimants when the Bank’s mortgage predated the mechanics liens, the foreclosure sale proceeds were insufficient to satisfy all claims, and the mortgagee-Bank had paid for several improvements to the property through construction loan escrow disbursements.
In LaSalle, the mechanics lien claimants acknowledged that the mortgagee-Bank was entitled to foreclosure proceeds allocable to the unimproved value of the land, but asserted that mechanics lien holders were entitled to foreclosure proceeds priority over ALL non-perfected improvement claims. The Court disagreed and instead found that upon distribution of foreclosure proceeds, the mortgagee-Bank was entitled (based on apportioned percentages between unimproved land value and the improvements’ value): (i) to the value of the unimproved property; and (ii) to participate in the value of improvements to the extent “paid for by the mortgagee-Bank”; that is, paid for by funding through construction escrow (and, based on the 1872 case the Court cited, even to the benefit of any improvements paid out of pocket by the Owner).
This is an important holding that clarifies priority and distribution of mortgage or mechanics lien foreclosure proceeds in the often suffered event of a foreclosure failing to yield sufficient sale proceeds to pay all claims. Lenders have been provided further certainty that their loan proceeds used to pay for construction improvements will be valid claims afforded pro rata participation along with other mechanics lien holders in share of foreclosure proceeds.
Charles Curtis is a partner at SmithAmundsen, where he practices business and banking law, and, together with his partner Thomas Scherschel, represents lenders in commercial lending transactional and litigation matters.
This alert was written by Charles Curtis.