In the singular world of the New York building loan, it might not surprise you that the Lien Law has a correspondingly unique approach to the filing order of the building loan agreement, the Section 22 affidavit and the building loan mortgage. Failure to file in the mandated order can have draconian results for a lender.
Mandated Filing Order
Failing to file or delaying to file a mortgage in any jurisdiction is potentially fatal to any lender. New York is not unique in that regard. In New York, however, failing to file a building loan mortgage in the wrong order – even just with respect the same lender’s own building loan documents – can result in the lien of the building loan mortgage being deemed subordinated to valid mechanics liens regardless of whether the mechanics liens were filed before or after the building loan mortgage.
New York requires that a building loan agreement and its accompanying Section 22 Affidavit be filed in the office of the county clerk “on or before the date of recording the building loan mortgage…. If not so filed the [borrower’s and lender’s] interest … in the real property affected thereby, is subject to” a subordination penalty. That is, a valid building loan mortgage cannot be filed even a day before the filing of the corresponding building loan agreement and Section 22 Affidavit.
(Incidentally, for experienced practitioners who wonder why in New York City specifically the building loan agreement and the Section 22 Affidavit are filed with the county clerk but the building loan mortgage – like other mortgages – is filed in the Office of the City Register, that is purely statutory. The Lien Law expressly states that “[n]o … building loan [agreement] … shall be filed in the register’s office of any county.” By contrast, mortgages are required to be filed in a county’s register’s office unless the county doesn’t have a register’s office, in which case the mortgage is to be filed with the county clerk.)
Changing “The Ordinary Priority of Liens”
As the New York high court put it in Altshuler Shalam Provident Funds, Ltd. v GML Tower LLC, “Failure to comply with these filing requirements changes the ordinary priority of liens, with a properly filed mechanics lien taking priority over the interests of the parties to the [building loan agreement]. Thus… the statute imposes a so-called ‘subordination penalty’ on a lender who does not do this. We have said,” the court noted, “that the Legislature enacted Section 22 to permit contractors on construction projects ‘to learn exactly what sum that loan in fact made available to the owner of the real estate for the project’”.
Why is the Penalty so Draconian?
New York’s concern with assuring that a trade contractor is aware of the net sum available – a crucial concept discussed in other installments of this series – was so keen that, even if a day passes between the filing of a building loan mortgage and the later filing of the building loan agreement and its accompanying Section 22 Affidavit, any such delay would warrant the worst possible outcome for a lender: the possible subordination of its building loan mortgage to mechanics liens, rendering it difficult to impossible for a mortgage foreclosure to wipe out valid intervening mechanics liens.
The rationale behind the harshness of the subordination penalty seems to turn on the idea that a properly calculated Section 22 Affidavit will almost always show contractors a “net sum available” that is less than the stated amount of the building loan mortgage. Why is that? Because the stated amount of a building loan mortgage will be the sum of (i) the portion of a building loan that is set aside to pay “cost of improvement” expenses but is not necessarily available to pay contractors, and (ii) the portion of a building loan that is set aside to pay costs of “improvements,” which are specifically earmarked to pay contractors. (The crucial difference between the statutorily defined terms “costs of improvement” and costs of “improvements” – a confusing choice of phrasing in the Lien Law – is discussed in other installments of this series.)
Summary and Upcoming Installments
The upshot is this. New York does not tolerate even a day’s delay during which contractors would have constructive knowledge of the mortgage loan amount, if they don’t also have constructive knowledge of the net sum specifically earmarked to them out of that mortgage amount and the conditions under which that net sum will be made available to pay them. In trying to avoid that scenario at all costs, the Lien Law authorizes courts to impose the harshest of penalties on a construction lender who fails to follow the mandated filing order: subordination of its mortgage lien to mechanics liens a lender would otherwise be able to wipe out in foreclosure.
You might also wonder whether the filing order requirements apply to building loan modifications? Yes, but there’s more. The Altshuler court also noted that “Section 22 … mandates the filing of any subsequent modifications of the building loan [agreement] within 10 days after their execution.”
We address that question in our discussion of building loan modifications elsewhere in this series.
