For mechanic lien claimants having “priority” is a charmed state. Priority refers to the ordering of claims against a piece of real estate. Claims with first priority get paid first from the proceeds of a sale or foreclosure.  Being “junior” can mean no payday at all.

Minnesota, like most states, has its own rules for determining priority.  The usual contest is between mechanic lien claims and a mortgage.  The rules in the Minnesota lien statutes strike a balance between the rights of each and the mortgage often wins by being recorded before the work starts.  It happens sometimes, however, that visible work starts before the mortgage gets recorded.  In that case, the mechanic lien claims are first in line to share in the proceeds of a sale or foreclosure.  But, what if somehow a mortgage could then jump back in front of the liens?  Payday could disappear. The Illinois case of REEF-PCG, LLC v 747 Properties, LLC may provide a cautionary tale.

The Illinois Supreme Court has not issued an opinion yet, but the trial court and the appellate court left open the prospect that a mortgage could do just that in Illinois based upon an old Illinois case from 1919.  If it works in Illinois could it happen in Minnesota?

In the Illinois case, a group of lien claimants had priority over a substantial mortgage under Illinois law.  The case involved half-completed tenant improvements to the mortgaged property.  The lender foreclosed and commenced a receivership. In that receivership, the lender moved the court for permission to lend new money to complete the improvements (which would enhance the lender’s collateral in the property but leave the lien claimants essentially unpaid). The Receiver argued that it could not borrow the needed money without a first priority lien. Based on a 1919 case in which a receiver was authorized to do that, the trial court granted the motion. The appellate court did not overrule that proposition.  The lien claimants then launched the present appeal to the Illinois Supreme Court.

An unfortunate result of the COVID-19 pandemic will almost certainly be an increase in distressed properties and defaults.  Until recently lenders would routinely turn to the traditional process of foreclosure.  Foreclosure sales were subject to rights of redemption which might draw the process out for more than six months.  Minnesota law and many commercial mortgages permit the appointment of a receiver. Where might that lead us?

Minnesota Statutes Chapter 576 establishes a statutory framework for receiverships of many kinds, not just for distressed properties. The statues do appear to leave open receivership not just as part of the formal foreclosure of mortgages but also perhaps outside of traditional foreclosure.  For instance “in connection with adverse claimants.” (Minn. Sta. 576.22 subd 18).  A receiver can sell “free and clear” which would not change the order of priority.  A receiver outside of the formal foreclosure process may decide to complete a stalled project, however.  That means a need for the receiver to borrow the necessary funds.  Chapter 576 gives the receiver the power to obtain not only unsecured debt without a court order but also that new secured money—perhaps with enhanced priority.

The statute provides in Minn. Stat 576.44 (c); “The court may authorize the receiver to obtain credit or incur indebtedness, and the court may authorize the receiver to mortgage, pledge, hypothesize or otherwise encumber receivership property as security for repayment of any indebtedness.”  [Emphasis added].

Just how far might that go? Could this enable a receiver to bypass the foreclosure process and take new financing (enhancing the lender’s collateral) and jump over the lien claims? If the Receiver must get court authorization the lien claimants could at least object with an appeal to equity and perhaps prevent the circumvention of their priority, but the ultimate answer is unknown, and the result could be big trouble for the lien claimants. Perhaps the REEF-PCG case will yet give us a strong hint.

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