The Lien Law Clause is New York's Advantage

The Effect of Lien Law 13(5) Upon Conveyancing

By Steven G. Rogers*
Vice President, National Manager & Counsel
First American Title Insurance Company of New York
Published in the New York Law Journal
on November 29, 1990 as
"Distinct Trust Fund Provisions Provide Unique Protections"

INTRODUCTION

As is the case in each other State in the United States (along with the District of Columbia), New York has enacted a statutory scheme by which those who provide materials and labor for the improvement of real property may obtain a lien against the improved property. While each jurisdiction has its own system determining the means by which mechanics' or construction liens attach, their priorities and enforcement, generally, there are similarities and differences between jurisdictions.

New York's system contains one distinct feature that is found in no other State. That is the trust fund provision , which calls for the inclusion of what is commonly known as the trust fund or "lien clause" in conveyance instruments. This distinction provides certain unique protections to those conveyed an interest in real property, whether by deed or mortgage.

As a result of this distinction, the underwriting of mechanics' lien issues by title insurers in connection with the insuring of properties located in New York State differs from other jurisdictions. Below will be discussed the effect of the lien clause in New York and a comparison with other mechanics' lien statutes outside of New York. Also to be discussed, are considerations in title insurance underwriting resulting from those differences.

DIFFERENT SCHEMES NATIONALLY

A review of mechanics' and construction lien statutes nationwide discloses essentially three different types of statutory schemes in connection with the attachment and establishment of the priority of such liens: 1) whereby priority is established by the date on which materials or labor are first provided (or the commencement date), so long as an inchoate lien is filed or recorded ("Type 1") ; 2) whereby priority is established by the date of filing of a notice of commencement or the lien itself ("Type 2") ; or 3) whereby priority is established by the initiation of judicial action ("Type 3") .

The majority of jurisdictions, including New York, fall within scheme Type 1. In these States, upon the commencement of the furnishing of materials or performance of labor, as set forth in the particular statute, the mechanics' or construction lien is inchoate until the filing or recording of the notice of lien in the manner prescribed by statute. In order for work to be that which is generally recognized as the commencement of a building under mechanics' or construction lien statutes, "it must be obvious from that done on the premises that a building is going up." Once perfected, the lien in these states attaches as of the date of the commencement, though not so in New York due to the lien clause.

New York's Lien Law requires the filing of a Notice of Lien in the clerk's office in the same county as the premises provided with the materials and/or labor at any time during the furnishing of the same within eight months following completion, or within four months for improvements on a single family dwelling. While the Lien Law is a remedial statute to be construed liberally, this liberal construction can in no way be used by the Courts to excuse the failure to comply with the statutory requirements in perfecting the lien, which will be strictly construed. Once perfected, but for the lien clause, the lien will be afforded priority as of the commencement date.

In all Type 1States, other than New York, with some exceptions, priority will be given the lien as to all conveyances not yet recorded at the date of commencement. In Arizona and North Dakota, the lienor is not given priority if it has actual knowledge of a competing interest not recorded. In Illinois, it is the date of the contract between the owner of the premises and the provider of the materials and/or labor, not the commencement date, which determines the priority of the resulting lien. This lien has priority over all conveyances of the affected premises, whether executed or recorded before or after the contract date. In Missouri, a mechanics' lien attaching as a result of new construction is provided priority over existing, filed mechanics' liens and recorded encumbrances and over those subsequently filed and recorded as well, while those for repairs do not. A mechanics' lien in Oregon takes priority over previously existing mortgages and encumbrances as well, except in the case of a lien for one who prepares the land for construction or draws up plans for landscaping.

New York is the only jurisdiction to protect grantees and mortgagees acquiring their interests subsequent to the commencement of that which gives rise to a mechanics' lien by virtue of the lien clause provided in Lien Law 13. It is not the only jurisdiction, however, which provides protection for subsequent bona fide purchasers ("BFP") and holders of purchase money mortgages. For example, a purchaser for value in Alabama will not be subject to an inchoate mechanics' lien so long as he does not have notice, actual or constructive, of the facts which gave rise to the lien. In Iowa, where, by statute upon filing, a mechanics' lien has priority from the date of commencement , it has been held that a purchase money mortgage is superior to a lien for improvements, even if the mortgage was executed and recorded after material and labor had been provided. It should be noted, however, that the lien clause in New York does not preserve the priority of a purchase money mortgage where its holder, as vendor of the premises, had knowledge of or consented to the work that gave rise to the mechanics' lien.

A number of States (see note 5) fall within scheme Type 2. This scheme is distinguished from Type 1 in that the lien is not inchoate upon the commencement of the furnishing of labor or materials. The priority of mechanics' and construction liens in these states is established as of the date of the filing of a notice of lien as prescribed in the particular jurisdiction. However, this does not mean that priority can not be as of he time of commencement. For example, in both Florida and Kentucky a Notice of Commencement or Notice of Intent may be filed upon the furnishing of materials and labor. This will preserve the priority of the lienor upon the later filing of the lien.

Finally, in the States (see note 6) which fall within scheme Type 3 priority is established as of the date that judicial action is sought. For example, in New Hampshire, a lien for labor and/or materials is secured by a Writ of Attachment, which establishes priority as of that date. Similarly, in Maryland, a petition to establish a mechanics' lien is filed and the lien does not attach until it is established by judicial order. It is subordinate to any interests, liens or encumbrances that have already attached to the property. These jurisdictions are distinguished from Delaware, which also establishes mechanics' liens judicially. In Delaware, the established lien relates back to the day the labor commenced and shall take priority accordingly.

It is the inchoate nature of the mechanics' and construction liens attaching to those properties located in jurisdictions following scheme Type 1 which is of concern to purchasers, lenders and title insurers alike. While protecting the interests of those providing labor and materials in order to improve real property, providing comfort to those that provide such services that they will receive payment, it is at the expense of those who traditionally rely upon the public record in order to determine the status of title of a particular property. Conversely, those jurisdictions, which fall within scheme Types 2 and 3 preserve the reliance upon the record. However, they do not provide the same level of protection provided by the majority of the States to contractors, sub-contractors and materialmen. It is these concerns that the trust fund provision of New York's Lien Law 13(5) obviates.

LIEN LAW 13 (5)

The purpose and intent of the Lien Law is to protect those who have directly expended labor and materials to improve real property at the direction of a general contractor or owner of a construction project. To this end, "(a) lien for materials furnished or labor performed in the improvement of real property shall have priority over a conveyance, mortgage, judgment or other claim against such property not recorded, docketed or filed at the time of the filing of the notice of such lien..." Further protection is provided by giving the mechanics' lienor priority as of the commencement date of the furnishing of labor and/or materials. However, by doing so, such a system is then protecting this class of parties at the expense of those receiving a conveyance of an interest in real property.

Traditionally, prior to one taking delivery of a conveyance of real property, whether by deed or mortgage, a search of the clerk's office in the county of situs of the property is conducted in order to disclose any matters which may affect the marketability of the title to said premises. The Recording Act was enacted to protect the rights of innocent purchasers who acquire an interest in property without knowledge of prior encumbrances, and to establish a public record which will furnish potential purchasers with actual or at least constructive notice of previous conveyances and encumbrances that might affect their interests and uses. It does so in that any conveyance that is not duly recorded in the proper county clerk's office will be void as against any subsequent good faith purchaser for value that does record. The jurisdictions that provide that a mechanics' or construction lien is inchoate until filed leaves the purchaser vulnerable for the period provided to file or record the lien. This is not consistent with the purpose of maintaining a complete record which can relied upon by subsequent lenders and purchasers.

What is unique about the Lien Law in New York, as compared to the rest of the country, is that it provides protection to those who furnish materials and perform labor in the improvement of real property, while at the same time, protecting subsequent purchasers by preserving the integrity of the record. Subsequent purchasers and secured lenders can rely upon the record and do not run the risk of being subject to inchoate liens that are filed subsequent to the recording of their conveyance instruments.

A lienor has a period of eight months following the completion of the improvements or furnishing of materials (four months if a single family residential property) in which to file their notice of lien. Any conveyance instrument filed subsequent to the commencement of the improvement would be subject to the validly filed notice of lien unless it contains a covenant similar to the following:

AND the party of the first part, in compliance with Section 13 of the Lien Law,covenants that the party of the first part will receive the consideration forthis conveyance and will hold the right to receive such consideration as a trustfund to be applied first for the purpose of paying the cost of the improvementand will apply the same first to the payment of the cost of the improvementbefore using any part of the total of the same for any other purpose.

Alternatively, a statement as simple as, "subject to the trust fund provisions of section thirteen of the lien law" may be used.

The party taking delivery of the instrument containing this covenant can rely upon the record in determining the status of title and those matters that effect it. They are not vulnerable to an inchoate lien being filed following the conveyance which springs into priority ahead of the interest conveyed to them. It adds an element of predictability for the purchaser not found in the other States that make use of scheme Type 1.

The above lien clause requires that the grantor or mortgagor has an obligation to use the consideration or loan proceeds received to first make payment to those who have furnished material or performed labor in improving the premises conveyed before using any of the funds received for any other purpose. Further, the grantee has no obligation to ensure in any way that the grantor has properly applied the proceeds of their transaction. Since the lienor has the trust res to look to, he then can not enforce his lien against the interest that is evidenced by the instrument recorded prior to his lien. His recourse is directly against the grantor.

Accordingly, where a notice of lien is filed prior to the recording of a conveyance that contains the lien clause when the instrument of conveyance was delivered to the grantee or mortgagee prior to the filing of said notice, absent any proof of collusion or fraud, the lien will not be valid against the interest of this grantee.

It should be noted that this provision does not apply where the conveyance is a referee's deed or from one who has been judicially appointed solely for the purpose of selling real property, nor does it apply where the grantor has entered into a contract which is recorded prior to the commencement of the improvement and conveys to the party making such improvement and said conveyance will be subject to any liens filed prior to its recording.

TITLE INSURANCE CONSIDERATIONS

As a result of the Lien Law 13(5) trust fund, the underwriting practices of title insurers of New York property in connection with inchoate mechanics' liens are somewhat different from those of title underwriters of property located in other States. So long as the instruments of conveyance contain the lien clause, inchoate mechanics' liens need not be addressed since the purchaser and/or lender will be conveyed their interests free of the same for the reasons set forth above. Generally, the only mechanics' liens of concern are those duly filed in the county clerk's office that should be disclosed during a search of the clerk's records. Nor are inchoate liens a concern in those States that follow scheme Types 2 or 3. This is not the case, however, in the majority of jurisdictions.

When real property located in any States with scheme Type 1 (other than New York) is to be conveyed, the issue of inchoate liens is always of concern. Especially in the case of commercial properties such as shopping centers or office buildings that are constantly undergoing repairs and renovation. Very often, it becomes difficult to accurately pinpoint just what labor or materials may have been provided to the premises prior to closing.

When closing a transaction involving a property in one of these jurisdictions, the issue is addressed by providing the title insurer with affidavits and/or indemnities. The owner of the premises will generally provide an affidavit which states that the improvements on the real estate were completed, and that there has not been any new construction or major repair work performed on the real estate for at least the period within which the inchoate lien could be filed in the particular jurisdiction. Further, the affidavit will state that the owner of the premises in question has not contracted for any labor or materials to be furnished that might become the subject of a lien or that such labor or materials, if furnished, has been paid for in full. If the owner can not make thoe representations, then an indemnity in favor of the title insurer will be necessary in order for a policy of title insurance to be issued without raising an exception to coverage with regard to any inchoate liens which may take priority over the interest insured.

CONCLUSION

Clearly, the advantage of New York's Lien Law 13(5) when compared to other jurisdictions is that the interests of both those that furnish material and perform labor in the improvement of real property and those that rely upon the public record are adequately protected. While a lienor may establish the priority of their lien as of the commencement date of the labor or material provided, purchasers and lenders may still rely upon the record and not be subject to any mechanics' liens that were not discoverable until filed.

 

*Steven G. Rogers is a Vice President, National Manager & Counsel with First American Title Insurance Company of New York. He received research assistance from Rodney Shenman, an Assistant Counsel with First American

76 NY Jur. 2d Mechanics' Liens 138 (1989) Please note that the treatment of building loan mortgages is beyond the scope of this discussion. "Type 1" States: Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Montana, Nevada, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, South Dakota, Tennessee, Texas, Utah, Vermont, Virginia, Washington, West Virginia, Wisconsin "Type 2" States: Florida, Kentucky, Louisiana, Maine, Massachusetts, Mississippi, Nebraska, New Jersey, Pennsylvania, Rhode Island, South Carolina "Type 3" States: Maryland, New Hampshire "What Constitutes "Commencement of Building or Improvement" For Purposes of Determining Accrual of Mechanic's Lien," J.R. Harvey, 1 A.L.R. 3d 822 2 Lien Law 10 76 NY Jur. 2d Mechanics' Liens 4 (1989) Lien Law 13(5) AZ ST 33-992, A.R.S. 33 ?992; NDCC 35-27-03 IL ST CH 770 60/1, 770 ILCS 60/1 IL ST CH 770 60/16, 770 ILCS 60/16 MO ST 429.050, V.A.M.S. 429.050, as interpreted by Trout's Investments, Inc. v. Davis (MO App., 1972) 482 S.W. 2d 510. OR ST 87.010, O.R.S. 87.010 AL ST 35-11-211, Ala. Code 1975 35-11-211 Meads v. Dial Fin. Co., 56 Ala. App. 84, 319 So. 2d 281 (1975); Douthit v. Wilkes, 480 So. 2d 547 (Ala. 1985) IA ST 572.18, I.C.A. 572.18 Midland Savings Bank v. Stewart Group, LC, (Iowa, 1995) 533 N.W.191 Bedford Lake Park Corp. v. Twelve Linden Corp., 8 AD2d 834 (1959, 2d Dept.) FL ST 713.07, West?s F.S.A. 713.07 KY ST 376.010, KRS 376.010 NH ST 447:10, R.S.A. 447:10 NH ST 447:12a, R.S.A. 447:12a MD REAL PROP 9-106 The Maryland Institute for Continuing Professional Education of Lawyers, Inc. (February, 1996) "Mechanic's Liens and the Maryland Trust Fund Law and the Maryland Prompt Pay Statute", David F. Albright, Jr., Esq., et al, Priorities (S9-108) DE ST TI 25 2735, 25 Del. C. 2735 West-Fair Elec. Contractors v. Aetna Cas. & Sur. Co., 87 N.Y.2d 148, 638 N.Y.S.2d 394, 661 N.E.2d 967 (Court of Appeals, 1995) Lien Law 13(1) Witter v. Taggart, (1991) 78 N.Y.2d 234, 573 N.Y.S.2d 146, 577 N.E.2d 338. New York Real Property Law 291 Lien Law 10 Lien Law 13 Standard N.Y.B.T.U. Form 8002 Lien Law 13(5) Id. Thurber Lumber Co., Inc. v. N.F.B. Development Corp., (N.Y.A.D. 2 Dept. 1995) 626 N.Y.S.2d 841, 215 A.D.2d 551 Leonard Engineering, Inc. v. Zephyr Petroleum Corp., (N.Y.A.D. 2 Dept. 1987) 522 N.Y.S.2d 900, 135 A.D.2d 795 Lien Law 13(5)


 
 
 
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