Construction & Mechanics’ Liens 2009:
An Introduction to the 3 New NCLTA Forms and
Reminder of 2006 ALTA Policy Coverages
This manuscript is primarily for introduction to the 3 new NCLTA forms, created just recently in response to the dramatically (exponentially) increasing claims due to owners (sellers, builders, developers) inability or unwillingness to pay their contractors (as defined in N.C.G.S. Chapter 44A) timely. For more detailed information about the statutes and case law, see several manuscripts available at --> Legal --> Bulls Bulletins Articles and Forms --> under “Construction” and under “Mechanics’ Liens”, especially “Mechanics’ & Materialmen’s Liens” by Williams, James W. III, and Ferguson, Nancy Short, last updated December 2007, on-line at
Mechanics’ and materialmen’s liens
The primary legal basis for the imposition of and the procedures regarding mechanics’ and materialmen’s liens are contained in N.C.G.S. Chapter 44A, Article 2. In addition, the priority analysis should be clearly understood by any attorney closing NC property transaction, -- not only Article 2 of Chapter 44a, but also the key cases addressing that priority, especially: Carolina Builders vs. Howard-Veasey Homes, Inc., 72N.C. App.224, 324S.E.2d626 (1985), Dalton Moran Shookv. Pitt Development Co., 113N.C. App.707, 440S.E.2d585 (1994), Electric Supply Co. of Durham, Inc., v. Swain Electrical Co., Inc., 328N.C.651, 403S.E. 2d291 (1991), and West Durham Lumber Co. v. Meadows, 179 N.C. App. 347, 635 S.E.2d 301 (2006), discr. rev. den’d.361 N.C. 704; 655 S.E.2d 404 (2007). In addition, in situations in which the subordinate lien is a federal tax lien, seeU.S. v. Mauney, 642 F. Supp. 1097 (1986).
Future Advance provision
Of course, the deed of trust must contain aprovision complying with either Article 7 or Article 9 of N.C.G.S. Chapter 45 in order to assure the priority to be established as of recording for the “future” advances to be made pursuant to the deed of trust after the closing. Article 7 of Chapter 45 of the North Carolina General Statutes (NCGS) provides a framework for ensuring the priority of future advances. According to NCGS45-70:
Any security instrument which conforms to the requirements of this Article shall, from the time and date of registration thereof, have the same priority to the extent of all future advances secured by it, as if all the advances had been made at the time of execution of the instrument.
NCGS45-68 sets forth those requirements that must be met in an otherwise valid security instrument to ensure the priority of those future advances, namely that the deed of trust must show:
(1)that it is given wholly or partly to secure future obligations which may be incurred thereunder;
(2)the amount of the present obligations secured, and the maximum principal amount, including present and future obligations, which may be secured thereby at any one time; and
(3)the period within which such future obligations may be incurred, which period shall not extend more than 15 years beyond the date of the deed of trust.
In addition, it makes no difference that the outstanding principal balance secured by the instrument fluctuates so long as the obligation(s) has been incurred within the timeframe and the maximum amount authorized in the security instrument and allowed under Article7 (NCGS4569). Note, however, that if the instrument secures a revolving line of credit, it must so provide.
Article9 of Chapter45 also provides a framework for ensuring the priority of future advances under an equity line of credit. According to NCGS45-82:
A mortgage or deed of trust which shows on its face that it secures an equity line of credit governed by the provisions of [Article 9], shall, from the time of its registration, have the same priority to the extent of all advances secured by it as if the advances had been made at the time of the execution of the mortgage or deed of trust, notwithstanding the fact that from time to time during the term of the loan no balance is outstanding.
NCGS45-81(a) defines an “equity line of credit” as “an agreement in writing between a lender and borrower for an extension of credit pursuant to which:
(1)At any time within a specified period not to exceed 30 years the borrower may request and the lender is obligated to provide (emphasis added), by honoring negotiable instruments drawn by the borrower or otherwise, advances up to an agreed aggregate limit;
(2)Any repayments of principal by the borrower within the specified period will reduce the amount of advances counted against the aggregate limit; and
(3)The borrower’s obligation to the lender is secured by a mortgage or deed of trust relating to real property which mortgage or deed of trust shows on its face the maximum principal amount which may be secured at any one time and that it secures an equity line of credit governed by the provisions of this [Article 9].”
Unlike Article7, in order to comply with Article9, the advances by the lender must be obligatory or the lender bound to make them, rather than the advances being optional. NCGS45-81(b) specifically defines “lender is obligated” in NCGS45-81(a) to mean “that the lender is contractually bound to provide advances.” Since October1, 1989, Article7 has not contained such a requirement; rather, the advances made under an Article7 security instrument may be optional to lender.
Neither Article7 nor Article9 provides a rule of priority for future advances absent compliance with its terms. While noncompliance in either case would not invalidate an otherwise valid deed of trust, future advances made thereunder would seemingly not be secured.
Future Advances and the ALTA 2006 Loan policy
Covered Risk #11 provides for coverage against loss or damage to the insured lender:
11. The lack of priority of the lien of the Insured Mortgage upon the Title
(a)as security for each and every advance of proceeds of the loan secured by the Insured Mortgage over any statutory lien for services, labor, or material arising from construction of an improvement or work related to the Land when the improvement or work is either
(i) contracted for or commenced on or before Date of Policy; or
(ii)contracted for, commenced, or continued after Date of Policy if the construction is financed, in whole or in part, by proceeds of the loan secured by the Insured Mortgage that the Insured has advanced or is obligated on Date of Policy to advance;
“Indebtedness” is defined in Conditions paragraph 1(d):
(d) “Indebtedness”: The obligation secured by the Insured Mortgage including one evidenced by electronic means authorized by law, and if that obligation is the payment of a debt, the Indebtedness is the sum of
(i)the amount of the principal disbursed as of Date of Policy;
(ii) the amount of the principal disbursed subsequent to Date of Policy;
(iii)the construction loan advances made subsequent to Date of Policy for the purpose of financing in whole or in part the construction of an improvement to the Land or related to the Land that the Insured was and continued to be obligated to advance at Date of Policy and at the date of the advance;
Since our North Carolina statute does not require that the advances be obligatory, and that is a situation that the lender and title insurer would prefer not to have to litigate among themselves, the lender should require a future advance endorsement, either specially crafted to coordinate with the North Carolina’s statutory structure (below), or the ALTA Endorsement Form 14 (Future Advance – Priority), which provides:
1. . . .
b.“Advances,” as used in this endorsement, shall mean only those advances of principal indebtedness made after the Date of Policy as provided in the Agreement, including expenses of foreclosure, amounts advanced pursuant to the Insured Mortgage to pay taxes and insurance, assure compliance with laws, or to protect the lien of the Insured Mortgage before the time of acquisition of the Title, and reasonable amounts expended to prevent deterioration of improvements, together with interest on those advances.
2.The Company insures against loss or damage sustained by the Insured by reason of:
a.The invalidity or unenforceability of the lien of the Insured Mortgage as security for each Advance.
b.The lack of priority of the lien of the Insured Mortgage as security for each Advance over any lien or encumbrance on the Title.
c.The invalidity or unenforceability or loss of priority of the lien of the Insured Mortgage as security for the Indebtedness and Advances resulting from (i) re-Advances and repayments of Indebtedness, (ii) lack of outstanding Indebtedness before an Advance, or (iii) the failure of the Insured Mortgage to comply with the requirements of state law of the state in which the Land is located to secure Advances.
. . .
4.This endorsement does not insure against loss or damage (and the Company will not pay costs, attorneys’ fees, or expenses) resulting from:
a.Advances made after a Petition for Relief under the Bankruptcy Code (11 U.S.C.) has been filed by or on behalf of the mortgagor.
b.The loss of priority of the lien of the Insured Mortgage, as security for Advances, to the lien of real estate taxes or assessments on the Title imposed by governmental authority arising after Date of Policy.
c.The loss of priority of the lien of the Insured Mortgage as security for any Advance, to a federal tax lien, which Advance is made after the earlier of (i) actual knowledge of the Insured that a federal tax lien was filed against the mortgagor, or (ii) the expiration of more than forty-five days after notice of a federal tax lien filed against the mortgagor.
d.The loss of priority of the lien of the Insured Mortgage as security for Advances to any federal or state environmental protection lien.
e.Usury, or any consumer credit protection or truth-in-lending law.
[f. The loss of priority of the lien of the Insured Mortgage as security for any Advance to a mechanic’s or materialmen’s lien.]
5.The Amount of Insurance shall include Advances.
See Urban, Whitney and Ferguson, “North Carolina Real Estate With Forms” Second Edition, Chapter 28, due to be published in 2009.
From the lender’s perspective, they must not make a disbursement to or for the benefit of the contractor in the face of known claims of lien on funds, must not become too embroiled in the construction project sufficient to create a joint venture relationship, and must comply with the construction loan agreement. They should consult their separate counsel, who should consult with the title insurer, if they have any questions. Even if the priority is clear, or especially if it is unclear or insufficient lien subordinations were obtained, it will be critical for the lender to notify the title insurer if any claim of lien is filed because of their duties both to cooperate, to notify the title insurer timely and to mitigate damages.
Modifications, Extensions, Renewals and other post policy matters
To the extent that any modification, extension or renewal may constitute a novation or otherwise jeopardize priority, the title insurer’s counsel should be consulted prior to making any assurance to a lender or requesting an endorsement. See, for example, McNeary's Arborists, Inc. v. Carley Capital Group, 103 N.C. App. 650, 406 S.E.2d 644 (1991).
Owner’s Coverage
The 2006 ALTA Owner’s Policy does provide for coverage against liens, defects or encumbrances on title as of the Date of Policy. However, in the situation in which the owner is contracting for the construction and obtaining the construction loan financing, the owner would not be protected against losses due to its own contracts under Exclusions 3 (a), (b) and (d):
3. Defects, liens, encumbrances, adverse claims, or other matters
(a) created, suffered, assumed, or agreed to by the Insured Claimant;
(b) not Known to the Company, not recorded in the Public Records at Date of Policy, but Known to the Insured Claimant and not disclosed in writing to the Company by the Insured Claimant prior to the date the Insured Claimant became an Insured under this policy;
…
(d) attaching or created subsequent to Date of Policy (however, this does not modify or limit the coverage provided under Covered Risk 9 and 10);
Three Coverage Situations ==> Three New NCLTA Forms
Three new forms for the 3 primary coverage situations are attached:
(1)No Recent Improvements – Affidavit and Indemnity
(2)Construction Recently Completed – Affidavit, Indemnity and Waiver by Contractor(s)
(3)Construction Contemplated or In Process – Affidavit, Indemnity and Subordination by Contractor(s) (Lender Coverage only)
Each form contains specific instructions at the end on when applicable and who must sign.
NOTE: No non-commencement was created. Experience has verified that it is very rarely the case that a lender is willing to make a construction loan, after substantial loan underwriting, unless there are Contractors already in place for the construction. Even if the attorney were to do a drive-by and no visible evidence of construction is noted, the architect, surveyor, equipment lessor, or others may have already begun long before, triggering the commencement date of whatever contract(s) they operate under with the owner. If the owner truly has retained a “general contractor” who will subcontract other services, that entire contract dates back to a first furnishing date as early as the design services if retained by that Contractor. In addition, if the closing is delayed even one day from the original date, it is highly likely that one of the Contractors will have started work.
Some key provisions to be noted with regard to the attached forms are the definitions, terms and issues below:
120-day Lien Period: This includes the period right up until the closing of the transaction and recordation of applicable documents – deed and deed of trust. Sometimes the waivers or subordinations are obtained over a period of days prior to closing. Sometimes closing is delayed because of lender funding delays or other issues. Often recently, even though the improvements were substantially completed long ago, last minute touch-up, punch list and even warranty work may be alleged to trigger and updated liability for “last furnishing.”
BEWARE THE CONTRACTOR WHO SHOWS UP FOR “WARRANTY WORK” or “JUST TO CHECK ON THINGS” just before or after closing … then files a claim of lien asserting that was the “last furnishing!!”
Owner, Agent and Related parties: This includes all persons or entities that have held title to the property within the past 120 days, whether they are still the owner at the time of closing or have only owned for a moment in time or are a co-owner. The statute also includes “agents,” presumably including officers, attorney-in-fact or others acting under agency principles. The form also includes a recommendation that the attorney contact the title insurer in the situation involving any “related” owner and contractor, so any question about whether a Contractor is an affiliate of an Owner and who should sign the appropriate lien form can be discussed with the title insurer prior to closing. Factors such as the separate corporate governance, maintenance of independent records, separate tax returns, differing owner, officers or board members, an arms-length negotiated construction contract, each entity having other projects with unrelated third parties, and similar factors substantiating that the Contractor is neither an “agent” nor subject to piercing of the corporate veil will assist the title insurer in making that determination.
Contractor: By statute, the Contractor is not the owner, no matter whether licensed under applicable licensing statutes (contractor, surveyor, architect, engineer) or not. The Contractor under chapter 44A is anyone providing Labor Services or Materials to the property under contract directly with the owner (even if the owner is also a licensed contractor).
NOTE: The term “general contractor” is intentionally avoided in the form because of the common misunderstanding of the term in the lien context.
Labor Services or Materials: These include not just traditional construction work such as lumber, grading, electrical or plumbing installation, but also the services of an architect, designer, surveyor or engineer, as well as lease of rental equipment for the construction.
Any variations in signatories or terms must be clearly discussed and agreed to with the title insurer prior to closing. Any notation should be included in the blank space under the provision “NCLTA Copyright; Entire Agreement.”
New Construction Addendum to the Offer to Purchase and Contract
The attorney should also be familiar with the Form 2A3-T “New Construction Addendum” form (Rev. 7/2007) adopted by the North Carolina Association of Realtors®, Inc. and the North Carolina Bar Association, for attachment to the Offer to Purchase and Contract. This form addresses many contract terms for completion of a specified home for the Buyer. Unfortunately, the Offer to Purchase itself does not lend itself to the needs to obtain actual waivers to protect the purchaser. Paragraph 14, Labor and Materials, provides: “Seller shall furnish at Closing an affidavit and indemnification agreement in form satisfactory to Buyer showing that all labor and materials, if any, furnished to the Property within 120 days prior to the date of Closing have been paid for and agreeing to indemnify Buyer against all loss from any cause or claim arising therefrom.” However, if actual Labor, Services or Materials have been furnished within the last 120 days, and affidavit and indemnity will not “show” payment or assure the title is free and clear of such liens. Hopefully this issue will be address by the Joint Forms Committee in the near future.
Chicago Title Insurance Company “Complex Closings, Claims and Consumer Protection” Feb 2009 – Page1