Illinois Governor Signs Law Altering how Lien Priorities are Determined in Mechanics Lien Situations

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February 13, 2013
Michael Cortina
SmithAmundsen Financial Services Alert

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Governor Quinn signed HB 3636 into law which drastically alters how lien priorities are determined in mechanics lien situations. Lenders are adversely affected.

This bill, HB 3636, was a response to the Illinois Supreme Court’s decision in the case of LaSalle Bank, N.A. v. Cypress Creek, LP, 242 Ill.2d 231 (2011). In Cypress Creek, the Illinois Supreme Court held that the bank was to be subrogated for the value of any mechanics lien improvements it had paid for, in addition to having lien priority for the value of the raw land on which it was given a mortgage.

The mechanics liens claimants had priority in the value of the improvements to the property that they made rather than priority to the value of the improvements as a whole. Cypress Creek was assailed by mechanics lien claimants as being an affront to the Mechanics Lien Act and argued that the bank should have only had priority to the value of the raw land and that the mechanics lien claimants should have had priority for the value of all improvements regardless of whether they were paid for by the bank or any other entity. Mechanics lien claimants based their arguments on their interpretation of the Mechanics Lien Act, but the Illinois Supreme Court overruled those arguments when it ruled in favor of the bank.

In response to the Cypress Creek decision, the Illinois House of Representatives filed HB 3636, which is an amendment to the Mechanics Lien Act. Under HB 3636, lenders who possess a mortgage lien on the property that existed before any contracts to improve the property were entered into will have priority over any subsequent lien holders only for the value of the land; any lien creditors shall have priority for the value of any improvements made to the property whether or not they were made by the lien creditor and whether or not they were paid for by the bank or any other entity. Of course, these provisions only take effect if there are insufficient funds to pay all creditors upon the sale of the property.

This law overrules the Cypress Creek decision and makes it so that mortgagees have priority over lien claimants only to the value of the raw land, and lien claimants have priority over mortgagees for the value of all improvements even if such improvements were not made by the lien claimant. Lenders will now be forced to re-evaluate construction lending as a whole since they are no longer able to subrogate or “step into the shoes” of lien creditors by paying for their improvements and getting, in return, priority for the value of those improvements.

For example:

A mortgage holder has a $2,000,000 mortgage on a project, and the land is worth $2,000,000. Contractor 1 has completed $1,000,000 worth of work on the project, has not been paid, and has a $1,000,000 mechanics lien on the project. Contractor 2 has completed $1,000,000 worth of work on the project, and has been paid with loan proceeds secured by mortgage holder’s mortgage. The improvements constructed on the project are worth $2,000,000 total. That is to say that the value of the land on the project is 50% of the total project value, and the value of the improvements on the project are 50% of the total project value.

If the project goes to foreclosure sale, and is sold for $3,000,000, the mortgage holder receives $2,000,000 for its mortgage and Contractor 1 receives $1,000,000 for its mechanics lien. However, if the project goes to foreclosure sale, and is sold for $2,000,000 (not enough to satisfy mortgage holder’s mortgage and Contractor 1’s mechanics lien claim), then under the Cypress Creek decision, the trial court would divide the proceeds 50/50 between land and improvements, and the mortgage holder would receive $1,000,000 for the land plus $500,000 for Contractor 2’s improvements because the lender paid for Contractor 2’s improvements, and Contractor 1 would only get $500,000 for its $1,000,000 mechanics lien. Under the bill signed into law yesterday, the lender would get $1,000,000 for the land, and Contractor 1 would get $1,000,000 for its $1,000,000 mechanics lien even though the bank paid for $500,000 for improvements.