Priority Breaks: New Title Guidelines on Construction Projects
Participants in construction loan transactions should be prepared for new title underwriting guidelines.
If you are engaged in real
estate development or construction, or in related financing transactions, you
are probably familiar with the term "priority break." A priority break can occur
when a general contractor or any of its subcontractors start to work on a
project before a construction mortgage is recorded, triggering the possibility
of the filing of mechanics' liens by the general contractor and by every
subcontractor on the project.
Consider this common example:
A fencing subcontractor starts work on a project before checking with the
general contractor to determine whether the construction loan has been recorded.
The result is a classic priority break that plagues the entire project, because
under Arizona law every subcontractor now has lien rights prior to the lien of
the construction lender, regardless of when each subcontractor actually performs
its work on the project.
The title company closing the
financing deal and insuring the lender's lien will notice the work when it
inspects on the day before or on the morning of the loan closing. At that point,
the title company informs the deal participants, who then scramble to find
solutions to the broken priority issue. Possible approaches to this problem may
include personal guarantees, bonding, indemnity agreements, letters of credit,
etc., some combination of which may allow the title company to insure the first
position of the construction lender. However, to the extent that these
approaches are available at all, they are usually time consuming and can delay
the funding of the construction loan.
In our experience, until
recently a simple drive-by performed by the title company (and perhaps a
representative of the lender) will obviate the issue: no construction, no
priority break. However, it has come to our attention that several of the major
title companies doing business in Arizona have been directed by their national
underwriting groups to treat every construction loan as a potential priority
break scenario, requiring the types of approaches discussed above, even when
there is not an actual priority break.
Depending on the title company you are using, you might need to plan for more
stringent title company requirements, and lenders may need to accept different
insurance coverage. Therefore, if you are contemplating a construction loan, we
invite you to call us (480-425-2600) to discuss the situation and potential
solutions. We can help you prepare for the possibility of extraordinary
prerequisites in closing your loan.