When “Past Due” Becomes “No Longer Due”

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Obligations are imposed on a party either as a debt that is due or a lien that encumbers property to secure a debt.  The law requires creditors to take action to enforce debts and liens within certain time limits.  Different types of debts and liens have different time limits for enforcement.  Each has a particular statute of limitations – a time limit for bringing court action or taking steps to enforce legal rights.

Some of the more common questions relating to loans and real estate collateral are answered below.

1.   How long does a creditor have to collect on a negotiable promissory note?

Six (6) years (UCC 3-118). A promissory note should have specific times for payments of principal and/or interest and a stated final maturity date.  For a negotiable promissory note, a creditor must take action and either collect or file suit within six (6) year of any specific due date.

2.   How long does a creditor have to collect a Demand Note?

Demand Notes do not have a stated maturity date but rather are payable upon demand of the note holder.  Once demand is made, creditor has six (6) years from the date of demand to enforce the demand note (UCC § 3-118).

There is an additional special rule for demand notes.  If no demand for payment is ever made on the Note, an action to enforce the demand note is barred if neither principal nor interest on the demand note has been paid for a continuous period of ten (10) years.

3.   How long does a creditor have to collect on a non-negotiable promissory note?

Four (4) years (Texas Civil Practice and Remedies Code – TCPRC – § 16.004).  Unlike demand notes, a promissory note should have specific times for payments of principal and/or interest and a stated final maturity date.  For a non-negotiable promissory note, a creditor may take action and either collect or file suit within four (4) years of any specific due date.

4.   What is the time limit to foreclose on real estate to collect a debt?

Four (4) years (TCPRC – § 16.035) from the date the payment becomes due.

5.   Wait.  I thought you said the statute of limitations on a promissory note is six (6) years, but a creditor only has four (4) years to foreclose?

The six year limit is to collect on a negotiable promissory note.  Within that six (6) years is a shorter four (4) year time limit to foreclose on the real property that secures that promissory note.

6.   What about collecting on a guaranty?  What is the time limited for suing a guarantor?

Four (4) years (TCPRC §16.004).  Most guaranties are guaranties of payment where the guarantor agrees to pay the debt on demand if the borrower fails to perform.  A creditor has four (4) years after demand is made on the guarantor to enforce the guarantee.

7.   Can a real property foreclosure affect the time limit against a guarantor or the borrower?

Yes.  If the foreclosure bid price is less than the unpaid balance of the debt, resulting in a deficiency, the deficiency lawsuit against the borrower or guarantor has to be brought within two (2) years of the foreclosure sale date (Texas Property Code §51.003).

8.   What about involuntary liens, such as abstracts of judgment?

If a person or entity is sued and loses a lawsuit and a judgment is rendered for damages, those damages are then due and payable.  If the losing party does not then pay, the winning party can file an abstract of judgment (“Abstract of Judgment”) in each county where the debtor may have assets.  The Abstract of Judgment is a general lien against all of the debtor’s non-exempt real estate assets.  The winning party has ten (10) years from the recording of the Abstract of Judgment to locate the debtor’s assets and have them sold to pay the debt (Texas Property Code §52.006).

9.   What about Governmental Liens?

Federal, state and local governmental units have the benefit of assessing liens if a person or entity does not comply with the law.  Some of the more common statutes of limitation time limits are listed below:

Municipal Street Improvement Liens: No limitation (Texas Transportation Code §313.054(d))

Municipal Health and Safety Liens: No limitation stated (Texas Health and Safety Code §342.007)

State Tax Liens: (Generally) no limitation (Texas Tax Code §113.105)

Water Control and Improvement District Liens: No limitation (Texas Water Code §51.509)

State of Texas Abstracts of Judgment: Twenty (20) years plus one possible twenty (20) year additional extension (Texas Property Code §52.006)

Federal Abstracts of Judgment: Against real property; twenty (20) years plus one possible twenty (20) year additional extension (28 U.S.C. §3201)

Ad Valorem Real Property Tax Liens: Twenty (20) years from the date of delinquency (Texas Tax Code §33.05)

Child Support Liens: Against real property – ten (10) years and may be renewed for subsequent ten (10) year periods (Texas Family Code § 157.318)

Federal Tax Liens: Ten (10) years from tax assessment date (26 U.S.C. 6502), but the period may be extended or suspended in certain circumstances.

County Ad Valorem Personal Property Tax Liens: Four (4) years from date of delinquency (Texas Tax Code §33.05)

State Liens for Sales and Use Taxes, Excise Taxes, Franchise Taxes and Inheritance Taxes to be collected by State Comptroller: Three (3) years after filing the tax lien notice (Texas Tax Code §111.202)

These issues can arise in connection with reviewing notes to be pledged as collateral, collection of past due notes, collection actions against guarantors, reviewing of credit report and reviewing of title reports.

These time limits are important.  Sometimes an action taken late is void and of no effect: if one fails to foreclose within the four year period, a later foreclosure has no effect and the creditor is unable to realize on its collateral.  In other cases, the action may not be void, but voidable.  For example, if a suit to collect a term note is filed more than four (4) years after the maturity date, the Borrower can raise the affirmative defense in court that the statute of limitation has passed.  If so, the creditor cannot enforce the debt.

We hope you have found this article useful.  If you have an interest in other topics, please contact us.

John Gambrell, November 6, 2012

This article is for marketing, general information and educational purposes only.  Although  this article has been prepared by attorneys with this firm, it is not intended to constitute legal advice or legal opinions which may be relied upon.  A legal result depends very much on the facts and circumstances and resulting special rules, issues, and exceptions in each situation.

© Opper & Gambrell, P.L.L.C. – 2012

So You Think You Have a First Lien Deed of Trust

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Most real estate loans are approved by the Lender with the understanding that the Deed of Trust recorded in favor of the Lender will be a first priority lien against the collateral property (the “Property”).  Most loans are also supported by a Loan Title Policy that insures the Lender’s lien validity and priority.

Certain facts and circumstances can exist that will defeat the priority of the Lender’s Deed of Trust.  Some of these events occur prior to the recording of the Deed of Trust while other such events can occur even after the recording of the Deed of Trust.

In Texas, matters affecting real property are to be in writing and the documents evidencing these matters are to be recorded in the Official Public Records of Real Property in the county where the land is located (the “Real Property Records”).  This recording system is the platform that notifies the public about matters affecting title to the Property.  Texas uses the “race-notice” theory of law to determine priority.  As to the Property, everyone is charged with knowledge (i.e., has “notice”) of (a) any title matters that one has personal knowledge of (whether recorded or not) and (b) any title matters that could be found in the Real Property Records in the County (whether one actually has knowledge, or investigates or not).  At the time the Lender records the Deed of Trust, a Lender “races” to the court house to file the Lender’s lien before someone else files something adverse to that lien.  The person who records first without knowledge of a prior claim or interest has priority over that prior claim or interest.

Instead of actually investigating title to the Property, the Lender relies on the title search or title insurance policy (“Loan Policy”) issued by the title company.  Title Policies are insurance of title against past occurrences and facts.  The Loan Policy generally does not insure the Lender against facts and circumstances that occur after the date of the Loan Policy, but the Loan Policy does provide insurance against recorded instruments that did exist on the date of the Loan Policy, but were not disclosed to the Lender in the Loan Policy.

Existing Conditions and Facts.

The following circumstances can exist as of the date of recording of the Deed of Trust that would have priority over the Deed of Trust.

1. Unexpired liens.  Under Texas law, voluntary liens such as a deed of trust continue as a valid lien against the Property until four years after the latest maturity date of the lien disclosed in the Real Property Records.  However, under federal law, liens originally in favor of the U.S. Small Business Administration never expire.  Even if the SBA loan is sold to a third party, the lien continues to exist until the debt is paid.  This creates exposure to the Title Company as does any title matter not discovered by the Title Company and disclosed in the Loan Title Policy.

2. Start of Construction.  In Texas, the owner of the Property (“Owner”) can have a construction contract (sometimes called a “Prime Contract”) with a contractor, referred to as an “Original Contractor” or generally as a “General Contractor”, to construct improvements on the Property.  The General Contractor may also contract with subcontractors to help with the construction work.  The Owner and the Original Contractor have a contract between them that protects them both.  The subcontractors, however, are not under contract directly with (“in privity with”) the Owner.  Texas law provides mechanisms for both the Original Contractor and the subcontractors to be paid for materials delivered to and construction work performed on the Property.  The mechanisms allow for the Original Contractor and the subcontractors to file affidavits claiming a lien if they are not paid.  The filing deadlines are between two and four months after each month in which their work is done.  In practice, all these lien filings tend to occur during construction, but  after the Deed of Trust has been recorded.  In general, no matter when a subcontractor files a lien, all of the lien claimants have the benefit of the “relation back doctrine.”   That doctrine provides that any such lien filed relates back to (i.e., takes effect retroactively back to) the first day that anyone under the Prime Contract delivered materials to or started work on the Property.  So if any materials have been delivered to the Property or if any work has been performed on the Property before the Deed of Trust is recorded, any of the workers and suppliers that perfect their liens will have priority over the Deed of Trust.  Title insurance does not cover this risk in Texas.  Therefore, Lenders must have an effective “clear lot” inspection procedure to insure lien priority.  Note that a loan title policy does not insure that there are no liens or claims superior to the Deed of Trust, but only that there are no lien claims filed of record of the time of closing.

Future Conditions or Facts (the Leap Frog Liens).

There are several events that can occur after a Deed of Trust is recorded, which under law either take effect retroactive to a date in the past or are deemed to be superior liens, all of which will have priority over the Deed of Trust.  None of these risks is covered by title insurance.

1. Ad Valorem Property Taxes.  Under Chapter 32 of the Texas Tax Code, each January 1 (for example, January 1, 2012) a super priority lien is imposed on the Property for unpaid ad valorem property taxes to be established for that year (which is also the personal obligation of the Owner of the Property).  Later that year, the Property is assessed, and in the fall (for example, October 15, 2012) tax bills are issued.  The property taxes are then due and payable but are not considered past due until February 1, 2013.  This statutory ad valorem tax lien arises automatically by operation of law.  It is not evidenced by the filing of any lien document and it has priority over any Deed of Trust.  Such tax liens may be refinanced by third party tax lien lenders under the Texas Tax Code and the Texas Finance Code.  The Borrower’s obligation to the tax lien lenders are secured by a Deed of Trust that will have priority over the Lender’s existing Deed of Trust.

2. Wage Liens.  Chapter 61 of the Texas Labor Code provides that if an employee is not paid by his or her employer (i.e., the Owner of the Property), the employee can file a wage claim complaint with the Texas Workforce Commission.  After review of the claim, the commission can issue a preliminary wage determination order to the employer (i.e., the Borrower).  The law provides for a wage claim appeal process and the employer’s chance for a hearing.  If no hearing is requested by the employer or the tribunal finds in favor of the employee, the wage claim appeal tribunal gives final notice of its decision.  When its order becomes final, that order is a lien on all property belonging to the employer, which lien is superior to any other lien on the Property except for the ad valorem property tax lien discussed above.

3. Street Improvement Liens.  Chapter 313 of the Texas Transportation Code provides that municipalities have the power to improve streets and to assess a portion of the improvement costs to the Property abutting that part of the street that is improved (and to the Owners of that Property).  Such assessment is a lien on the Property that is superior to any other lien, except for the ad valorem property tax lien discussed above.

4. Sanitation Liens.  Chapter 342 of the Texas Health and Safety Code provides that a City may regulate various conditions including existence of stagnated water, unwholesome conditions, weeds, rubbish or other unsanitary matters.  If the Owner of the Property does not comply with City ordinances, the City may issue a notice of violation.  If the Owner does not correct the violation, the City may correct the violation and charge the cost of the work to the Owner of the Property.  The City may then file a statement of expense in the Real Property Records.  This lien is superior to any other lien on the Property except for the ad valorem tax lien and lien for street improvements discussed above.

5. Government Forfeiture Claims.  As a matter of public policy, there are laws in place which can deprive criminals of their assets obtained by unlawful means.  There are both federal civil forfeiture statutes and criminal forfeiture statutes.  Texas law also provides a mechanism for forfeiture of contraband in Chapter 59 of the Texas Code of Criminal Procedure.  These liens or divestment of assets may not arise very often, but if they do, your collateral Property is in jeopardy.  The general approach of these laws is to provide that assets used in criminal activity, assets acquired as a result of the criminal activity, or assets acquired with the proceeds of the criminal activity are considered contraband.  The criminal prosecutor can file a lis pendens (notice of pending lawsuit which affects the Property) in the Real Property Records that gives notice that the Property is subject to forfeiture, that is that title to the Property vests directly to the government.  The burden then shifts to the Lender to prove the Deed of Trust lien should survive as a valid lien against the Property.

Under Texas law, the Lender would have to prove that at the time the Deed of Trust was recorded, (a) the Lis Pendens had not been filed and (b) that the Lender did not know or should not reasonably have known of the act or omission that would cause a forfeiture.  If the Lender cannot meet its burden of proof, then the Deed of Trust lien does not survive the forfeiture, the government can sell the Property and the Lender loses its rights in the collateral Property.  Under the federal criminal forfeiture statute the procedure is much the same, but there are differences.

Under the federal forfeiture statutes, the lis pendens notice does not work the same way as a regular Lis Pendens, an abstract of judgment or even a federal tax lien; all of these filings respect state law priority rules and attach to the Property at the time of recording, which would be behind existing liens such as the Lender’s prior Deed of Trust.  Instead, the federal criminal forfeiture statute provides that forfeiture of a defendant’s assets occurs retroactively to the time the criminal activity occurred, which could pre-date the Deed of Trust.  At the criminal trial, if the defendant is found guilty, part of the case is to perfect the seizure of the Property.  The forfeiture in essence invalidates the “subsequent” Deed of Trust lien, and the Lender has the burden of proof that it is an innocent party and that its Deed of Trust should survive.  The Lender will need to file a motion and have a hearing before the judge to prove that the Lender is, in essence, an innocent owner or a bona fide purchaser in its role as mortgagee (that is, the Lender loaned money secured by the Property without any knowledge of and without any consent to any criminal activity that could be the basis for a forfeiture).  Failure of the Lender to properly pursue its rights in court after a guilty verdict for criminal conduct that pre-dates the Deed of Trust will extinguish the Lender’s Deed of Trust.  The “take-away” here is the Lender needs to know its Borrower and to understand the Borrower’s source of assets and source of repayment for the loan.

Title reports and title reviews are important as part of the closing of a loan in order to review for these and many other issues.  Title updates are also important at various stages during the life of a loan with respect to loan modifications and construction loans.

We hope you have found this article useful.  If you have an interest in other topics, please contact us.

John Gambrell, September 27, 2012

This article is for marketing, general information and educational purposes only.  Although  this article has been prepared by attorneys with this firm, it is not intended to constitute legal advice or legal opinions which may be relied upon.  A legal result depends very much on the facts and circumstances in each situation.

© Opper & Gambrell, P.L.L.C. – 2012

Statutory Retainage in Texas for Lenders

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Statutory retainage is a specific legal requirement imposed on an owner of Texas real property undergoing construction, to hold back a portion of the progress payments due the general contractor for the benefit of any unpaid subs and suppliers for their work on the project.  Section 53.101 of the Texas Property Code requires the owner of real property undertaking construction of improvements to retain 10% of the contract price of the work until 30 days after completion of the work.  This is called statutory retainage and is required on every residential or commercial construction project inTexas.

 Because there is no statutory penalty for failing to comply with the retainage statute, many times, no retainage is withheld by the owner or by the lender making the construction loan.  InTexas, lenders usually do require retainage to be withheld on commercial construction loans, but rarely require retainage withholding on home builder loans.  On interim construction build on your lot” loans, retainage is usually required by lenders, subject to waiver if the borrower meets minimum liquidity requirements.

 True retainage is where the owner or lender requires that 10% of each progress payment be deposited into an account controlled by the owner or lender until 30 days after the project is finally completed, including punch list items.  This method is typically used on commercial construction projects.  On residential construction projects, usually there is a line item for retainage in the approved budget; and the loan proceeds for this line item are not funded until 30 days after project completion.  This method does not strictly meet the requirements of Section 53.101, but does have the practical effect of reserving loan proceeds for the benefit of unpaid subs and suppliers.

 If a sub or supplier is not timely paid by the general contractor, the unpaid party may record a notice of lien claim in the manner prescribed in the Property Code.  If the affidavit is properly and timely recorded, the sub or supplier has a right to a portion of the statutory retainage.  If the aggregate of claims exceed the 10%, the unpaid claimants share prorata the 10%.  If the owner fails to retain the 10% as required under Section 53.101, the owner will be responsible to the unpaid claimants up to the aggregate amount which should have been retained, plus the claimants’ attorney fees.

 There are practical alternatives to retainage.  The Property Code allows an owner and general contractor to obtain a payment bond and once the bond is recorded, lien affidavits do not attach against the real property but rather attach against the recorded bond.  Another method in lieu of retainage or in addition thereto, is to require the general contractor to provide trailing lien releases from all subs and suppliers or from subs and suppliers with work in excess of a certain threshold amount.

 The most common form of construction default is when a general contractor does not pay subs and suppliers, and mechanic’s lien claims are filed against the property.  A good retainage policy and payment verification procedure properly followed greatly diminishes the exposure of losses to both the owner and the lender.

Title Insurance for Lenders (Part II) Texas Title Binders

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In Title Insurance for Lenders-Part I, we discussed Texas Title Insurance in general and the primary functions of title insurance companies.  This Part II will focus on what the Texas Department of Insurance calls a Mortgage Title Policy Binder of Interim Construction Loan” or what we call a title binder. 

A title binder is a type of pre- insurance policy contract between a title company and a lender which may be issued on certain types of construction loans.  Title binders are available for builder direct loans where the builder owns the lot and the lender makes the loan directly to the builder for construction of a home.  Title binders are not available on “build on your lot loans”, where the consumer owns the lot, obtains the loan and hires a third party contractor to construct the home.  Title binders are also available on commercial construction loans, during the construction period. Nowadays, it is common for the construction lender to make a combined commercial construction loan with a short-term mortgage period (one to five years) to allow for lease-up and stabilization of the project.  On these loans the lender usually requires a loan policy at closing, rather than a title binder.

Title binders are unique toTexas title insurance and are not available in other states.  The primary advantage of utilizing title binders in lieu of loan policies is that the premiums are very economical.  The premium for a title binder, regardless of the size of the loan, is the minimum basic premium for a title policy, which is currently $229.00.  So, for example, on a $10,000,000.00 construction loan, the premium for a loan policy would be $41,309.00.  The premium for a title binder for the same size loan would be $229.00, a true value for the home building industry.

A title binder does not actually create title insurance coverage.  Rather, a title binder is a legal commitment on the part of the title underwriter to issue a loan policy, with the same coverage, exceptions, exclusions and conditions as stated in the title binder, upon payment of the title insurance premium.  If a title defect arises during the loan term, the borrower or the lender can pay the policy premium and the title underwriter is required to issue a loan policy.

The initial title binder expires one year from the date of issuance.  Thereafter, a title binder may be renewed for six, six month periods for a renewal fee of $25.00 for each renewal.  After four years, a binder cannot be renewed.  While the title binder is in effect, the lender may order down date endorsements for $25.00 each, which will extend the effective date of the title binder.

Title binders can be utilized in situations where parts of the loan proceeds are being disbursed for purchase money or refinance of debt on the property.  To issue a title binder in lieu of a loan policy, the title company must reasonably anticipate that a loan policy will be issued when the improvements are completed. A title binder may not be issued on a completed house, but renewals of an existing title binder may be issued.  A title binder may not be issued on a vacant lot loan except in cases where immediate improvements are contemplated.  On a one-to-four-family construction project, the builder is credited one-half of the title binder premium paid against the purchase of an owner policy for the purchaser within one year of issuance of the title binder.

Please contact Mary Wingfield (mwingfield@opper-gambrell.com) for a copy of the current form of the TDI title binder (T- 13) for your review.     

– Ron Opper 2012

EARLY STARTS ON CONSUMER CONSTRUCTION LOANS

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Overview

A popular type of new home construction financing in Texas is called “build on your lot” financing.  This is where the consumer owns the lot or purchases the lot at closing, hires a general contractor to build the home, and obtains construction and/or lot financing from the lender, either through a short-term interim construction loan or a combined construction/permanent one-time close loan.  This type of financing is commonly utilized for construction of principal residences, vacation homes and second homes.  Many times, the borrower resides in an existing home which is claimed as the borrower’s homestead property.  Whether or not the borrower has an existing homestead, lenders, title companies and their attorneys will require that these consumer loans be documented and closed as if the lot securing the loan is the borrower’s homestead.  The Texas Constitution and Section 53.154 of the Texas Property Code require that, for a construction lien for homestead improvements to be valid, there must be a contract for improvements signed by the owner(s) of the property, prior to commencement of any work under the contract.

On a contract for repairs or renovations to existing homestead improvements, there are some additional Constitutional requirements, namely, (i) the contract for improvements must be signed at the lender’s office, an attorney’s office or a title company office, (ii) there must be a five day cooling off period between making written loan application and signing the contract, and (iii) the owner(s) must be given a three day right to cancel the contract for improvements.  These additional requirements do not apply to homestead construction of new improvements on a vacant lot.

The Problem – Early Starts

Most lenders understand the basic rule that if work starts on a construction project before the lender’s deed of trust is recorded, the lender has a lien priority problem.  Some lenders think an early start is the title company’s problem.  In most instances, it is a problem for all parties involved in the construction project.

In a typical consumer construction closing, the escrow officer has the borrower and builder (also referred to as the general contractor) sign the mechanic’s lien contract and the construction loan agreement (together with other loan and closing documents).  The general contractor also signs a transfer to the lender of the mechanic’s lien contract.  The deed of trust contains a provision stating that the mechanic’s lien is renewed and rearranged by the deed of trust.  In other words, the mechanic’s lien creates the valid lien on the homestead for the costs of construction, the general contractor assigns the mechanic’s lien contract to the lender, and that lien is then renewed and rearranged in the deed of trust, creating a valid deed of trust lien on the homestead.  The moment the mechanic’s lien is signed by the borrower and the general contractor, a valid lien has been created.  At the moment the signed mechanic’s lien and the deed of trust are recorded in the real property records, the lien priority for the deed of trust is established.

In Texas, a party who performs labor or provides materials for construction of improvements, has a lien claim for payment against the property being improved.  On consumer construction projects in Texas, there is typically one original contractor known as the “general contractor.” If the party has a direct contract with the owner, then that party is an original contractor.  If the party does not have a direct contract with the owner, then the party is a subcontractor or supplier.  If an original contractor, subcontractor or supplier does not get paid for labor or materials, such party is entitled to a lien against the property being improved.  Chapter 53 of the Texas Property Code is very specific on how and when a lien claim must be filed.  The lien claimant must file a lien claim affidavit of record (generally by the fifteenth day of the third full calendar month after the last work was completed by the claimant) and must notify certain parties, including the owner, but not the lender.

Texas law provides that the priority of the lien claim of an original contractor, sub or supplier is established as of the date the first work was started or materials were delivered under the original contract, not from the date the lien claim affidavit is filed in the real property records.  Say, for example, a general contractor hires a cabinet company to install cabinets in the house the general contractor is building.  If the cabinet sub is not paid and timely files a lien claim affidavit against the property, the lien priority for the cabinet sub will date from the date work commenced or materials were delivered under the general contract.  This date of commencement may be when the slab site was cleared, when the slab form boards were set, or when the form board material was dropped on the site by the lumber company.  The policy of allowing the cabinet subcontractor to claim a lien from the date the initial work was commenced on the house is to allow all subs and materialmen to have equal lien priority under the general contract.

Title insurance in Texas does not insure a lender’s lien priority as to mechanic’s lien claims made for early starts.  The only insurance the title company is providing is that, as of the date the loan policy was issued, no mechanic’s lien affidavits existed against the insured property in the real property records.  Since Texas law establishes the mechanic’s lien priority date as being the date work started under the original contract and not the date the lien affidavit claim is filed, the title company is not insuring the lender’s lien as being superior to a valid unfiled mechanic’s lien claim which may still be filed legally after the recording of the deed of trust.  However, the title company is insuring that the deed of trust lien is a valid lien.  Let’s look at some hypothetical situations to see how this works out in real time, and what risks of the lender are insured and uninsured.

Hypothetical No. 1 – Loan Documents Timely Signed But Lender’s Liens Not Timely Recorded

Smith owns a vacant lot.  Since it’s the only property he owns, it is considered his Texas homestead, even though it is a vacant lot.  He hires Jones as his general contractor to build a house and make other improvements.  Smith obtains a loan, and Smith and Jones meet at the title company on Friday morning and sign the loan papers, including the mechanic’s lien contract and the deed of trust.  The title company escrow officer, Taylor, tells Smith and Jones that she has lender approval to fund and she will take care of closing and funding that same day.  Taylor then funds the loan transaction, but decides traffic is too bad to make it downtown to record the mechanic’s lien contract and deed of trust.  So she decides to record the lien documents first thing Monday morning.  Jones wants to impress Smith, so he calls his slab sub and tells the sub to start clearing the property first thing Monday morning.  The slab sub, who wants to impress Mr. Jones, starts the slab work on Saturday.  First thing Monday morning, Taylor records the mechanic’s lien and deed of trust and issues the loan policy.  Nine months later, Ms. Lee is hired to install kitchen cabinets.  She does her job, but doesn’t get paid for her work.  Her credit admin person files a mechanic’s lien affidavit within the filing period allowed under Chapter 53 of the Property Code.

Q: Is the deed of trust lien valid against the homestead?

A: Yes.  The mechanic’s lien was signed by the borrower and general contractor before any work under the contract was commenced, thereby meeting the Constitutional and Property Code requirements for a valid lien on homestead property?

Q: Is the cabinet sub’s lien claim superior to the lender’s deed of trust?

A.  Yes.  The lien priority date of the deed of trust was established on Monday, the date of recording of the mechanic’s lien and the deed of trust.  But, since work started under the original contract on the prior Saturday, the liens of all subs and suppliers are superior to the lender’s deed of trust lien, as the lien priority of all work under the general contract relates back to that Saturday.

Q: Does the loan policy insurance cover this?

A: No. The loan policy only insures (i) the lien is valid and (ii) there were no liens filed of record as of the date of the loan policy.  Schedule B of the loan policy on a residential construction loan will always have an exception that reads “any and all liens arising by reason of unpaid bills or claims for work performed or materials furnished in connection with improvements placed, or to be placed, upon the subject land.  However, the Company does insure the Insured against loss, if any, sustained by the Insured under this policy if such liens have been filled with the County Clerk of _______ County, Texas, prior to the date hereof.”  The cabinet sub’s lien is superior to the lender’s deed of trust lien, but is not covered by the title insurance because the lien affidavit was filed after the date of the loan policy.

Q: Does the title underwriter have any liability to the lender under the insured closing service letter for late filing of the mechanic’s lien and the deed of trust?

A: Possibly, but not likely.  Generally, an insured closing letter makes the title underwriter liable for the wrongful acts of the title agent and for losses caused by the title agent’s failure to follow the instructions of the lender.  The lender could include in its closing instructions letter in large font, bold type “Title Company must record the mechanic’s lien contract and deed of trust the same day as settlement.” However, a more prudent practice would be for lenders to take ownership of the issue by implementing and monitoring a clear lot inspection program.

Hypothetical No. 2 – Work Begins Before Signing

Same parties and same facts as No. 1, i.e., loan documents are signed on Friday and recorded on Monday. But let’s assume work began on Thursday, the day before the loan documents were signed.

Q: Is the deed of trust lien valid against the homestead?

A: No. Work began under the general contract before the mechanic’s lien contract was signed.  Therefore, under the Constitution and the Texas Property Code, the mechanic’s lien is not valid, so neither is the deed of trust lien.

Q: Does the title insurance cover this?

A: Yes.  The Loan Policy does insure lien validity.  Thus, the title company and the title underwriter will be strongly motivated to assist the other parties in curing the problem, if less inclined to cover out of pocket costs.

Q: How is the problem cured?

A: The short answer is that the title company will come up with a plan to cure the early start.  The plan will entail termination of the existing general contract, payment for work started, signed releases from subs and suppliers, execution of a new general contract for the remaining work, and curative amendments to loan documents.  The lender should rely heavily on its legal counsel in this process.

Hypothetical No. 3 – Early Start on a Non-Homestead Property

Same fact pattern as Hypothetical No. 2, except Mr. Smith owns a home, in which he resides and for which he claims a homestead tax exemption.

Q: Is the lender’s lien valid?

A: Yes. Since the mechanic’s lien is on non-homestead property, the lien is valid even if it is signed after work has started.

Q: Is the mechanic’s lien contract and deed of trust lien inferior?

A: Yes.  Since the lot cannot also be his homestead (until the homestead is “abandoned” by Mr. Smith), the mechanic’s lien and deed of trust liens are inferior to all timely mechanic’s lien affidavit claims properly filed under the general contractor.

The Solution- Education, Disclosure and Inspection  

1.  For most “build on your lot” customers, the construction project is their first foray into new home construction and they are, therefore, unfamiliar with the legal requirements and the process.  Sometimes, this is also true with the home builders constructing the home.  The loan officer should attempt to educate the borrower about the process, including selecting the contractor and understanding the need for statutory retainage, the responsibilities of the borrower for timely completion of the construction project, and how draw funding works.  Our firm has prepared a customer disclosure document for loan officers to utilize in order to better explain these issues to the customer.

2.  The lender should implement and closely audit a “clear site” inspection plan which requires same day lot inspection by the loan officer, the lender inspector or the title company, to verify no work has started and no materials have been delivered.

3.  The lender’s closing instructions to the escrow officer should be clear and require that the escrow officer instruct the borrower and the general contractor, that no work can be started until the escrow officer has approved the start either by voice or electronic communication.  The escrow officer should be further instructed to not approve commencement until the lender has communicated to the escrow officer that a successful clear lot inspection has been completed.  More on the methodology of clear site inspection best practices in the next blog post.

(c) Ron Opper 2012

Mechanic’s Lien Releases-Part II: Lender’s Utilization of Mechanics Lien Releases

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In Mechanic’s Lien Releases-Part I, we outlined the new provisions of Subchapter L to Chapter 53 of the Texas Property Code, which requires the use of four standardized release forms for construction contracts entered into on or after January 1, 2012. This “Just A Minute” issue explains typical lender practices regarding when lien releases are required by lenders on construction loans.

Construction Loans to Builders. Generally, Texas lenders do not require that homebuilders obtain releases from subs and suppliers as a condition to obtaining loan advances on construction loans made directly to the homebuilder. Typically, builder direct loans are thoroughly underwritten and builder guidance line letters are issued based on continual monitoring by the lender of financial performance of the builder, with a view toward a proper balance of spec and contract units in inventory. Most lenders will only require releases from subs and suppliers if a loan becomes delinquent, construction progress is not adequate, or subs or suppliers are not timely paid by the homebuilder.

Commercial Construction Loans. On construction loans other than single family homes, lenders usually do require lien releases from the general contractor, the subcontractors and suppliers. Some lenders require sub and supplier lien releases only for subcontracts meeting a minimum threshold amount (for example, minimum subcontract amount of $25,000.00). Progress payment releases are also required by the property owners, so copies of the originals are usually acceptable to lenders. Such lien releases are typically required on a “trailing release” basis, so when a contractor and owner submit a draw request, they will provide to the lender progress releases for those subs and suppliers who received progress payments from the prior advance. For example, when the contractor and owner submit a draw request for a framing line item advance, they will submit signed lien releases from subs and suppliers paid out of the immediately prior foundation/slab progress advance.

“Build On Your Lot” Construction Loans. One common method of new home building is for the consumer to own the lot, obtain the construction financing, either as a short term interim loan or as a so-called “construction-perm” one time mortgage, and hire a contractor to construct the home. On these types of loans, it is a common lender practice to require trailing lien releases, utilizing a procedure similar to obtaining releases on commercial construction loans.

Do you have a topic you would like us to cover? Submit your questions and ideas to Mary (mwingfield@opper-gambrell.com).

Mechanic’s Lien Releases-Part I: Required Statutory Forms

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The Texas Legislature added Subchapter L to Chapter 53 of the Texas Property Code. It requires the use of one of four standard forms for waivers and releases of mechanic’s lien rights of contractors, subcontractors and suppliers. Copies of the forms are available in Word format upon your request.  Except in some limited instances, if a party does not use the standard form, the waiver or release will be ineffective.  

 Explanation of Forms

1. Conditional Waiver and Release on Progress Payments.  This form is used for progress payments or interim loan advances.  This form makes the progress release conditioned upon receipt of the advance or progress payment, and good funds actually being received by the party signing the release. 

2. Unconditional Waiver and Release on Progress Payments.  This form is used for progress payments or interim loan advances where the party signing the release has already received good funds.  An example would be trailing lien releases where a contractor would be required to deliver a release for the immediately prior draw at the time of the current draw request.  An owner or lender is prohibited from requiring the contractor, subcontractor, or supplier to sign this form of statement if payment of good funds has not been received by the party signing the release.

3. Conditional Waiver and Release on Final Payment.  This form is used for final payment on a contract and it is a waiver and release of the lien conditioned upon receipt of the final payment (inclusive of retainage) in good funds.

4. Unconditional Waiver and Release on Final Payment.  This form is used for final payment on a contract and it is an unconditional waiver and release of the lien.  The party signing the waiver and release must have received good funds for final payment for this form of statement to be utilized.

Questions and Answers

Q: Can other forms be used?

A: In limited circumstances.  The forms are not required for releases of lien claim affidavits which have been filed of record or where there are disputes and litigation. 

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Q: Is a release form on a check still enforceable?

A: No.  It no longer has any legal effect.

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Q: Is a proper form signed but not notarized enforceable?

A: No. The form must be notarized.

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Q: Is a conditional progress or final release enforceable once good funds are received?

A: Yes.  No further release or statement is necessary.  Verification of good funds would include wire funds transfer receipt or a copy of the paid check.

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Q: Can a party require an unconditional release without the contractor having already received good funds?

A: No.

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Q: Can a contractor, subcontractor, or supplier “pre-release” its lien rights?

A: Yes, in limited circumstances. In a written contract or subcontract, for new construction, remodel or repair of a single family house, townhouse, duplex or for land development intended for such housing, where the contract is signed before labor or materials are provided, the lien rights can be waived in such contract. Such a waiver does not apply to a supplier who does not also install the materials it provides.  Nor does it appear a contractor can pre-waive lien rights on a commercial project unrelated to housing.

Stay tuned for Mechanics Lien Releases-Part II, which will address when and how partial releases should be obtained by lenders.  

Please contact Mary Wingfield (mwingfield@opper-gambrell.com) for a copy of the four forms in Word format.  If you have further questions or concerns, please feel free to call.

Title Insurance for Lenders (Part 1)

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Overview  

The underwriting policies for most lenders require title insurance coverage on real estate loans over a certain loan amount (e.g., $100,000). Title insurance policies protect property owners and lenders from losses due to title failure and most title defects. Title insurance coverage originated in the 1870s in Pennsylvania after the Pennsylvania Supreme Court ruled that an attorney giving a title opinion was not liable for an error in the opinion. The first title policy issued in Texas was in 1908 by Stewart Title Guaranty Company.

The business of title insurance is highly regulated, particularly in Texas. All underwriters, title agencies and escrow officers are required to be licensed with the Texas Department of Insurance (“TDI”). All title insurance forms are promulgated by TDI. The premiums for policies and endorsements are set by TDI. The TDI has promulgated the Basic Manual of Rules, Rates and Forms for writing of Title Insurance in the State of Texas (called the “Basic Manual”). It contains the insuring forms, special endorsement forms and procedural rules for insurance claims and procedures. A current copy is available online at www.tdi.texas.gov/title/titleman.html. In addition to state regulation, title agencies are subject to certain federal consumer regulations, specifically RESPA and Truth-in Lending (on settlement services relating to one to four family residences).

There are approximately twenty Texas licensed title insurance underwriters, although the vast majority of title insurance is underwritten by ten of these companies, and many of those companies are affiliated. Fidelity National Title Group, for example, owns underwriters Alamo Title, Lawyers Title, Chicago Title, Fidelity National Title and Commonwealth Land Title. There are over 550 licensed title agencies in Texas, and over 1,500 local title offices (which are either owned by the underwriters or their affiliates or are independently owned and have agency agreements with one or more underwriters).

Title Company Functions

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A licensed title agency in Texas has two primary functions. First, it acts as an escrow agent and handles the parties’ funds, documents and transaction closings (the escrow functions). Second, it provides title insurance coverage to property owners and lenders through issuance of owner and loan title policies.

The first contact with a title company in a typical real estate purchase transaction is for the escrow of the earnest money and the purchase contract. An escrow officer is assigned to the transaction and a title abstract is ordered from the abstract plant (either in house or from a third party). A title abstract will be created by the abstract plant and a title commitment will be prepared for issuance to the parties to be insured (the purchaser and the lender), usually within ten days of opening escrow. The title company agrees to issue title insurance coverage in accordance with the terms and conditions of the title commitment. A title commitment is effective for the ninety day period from the date it is issued. The title commitment is comprised of (i) Schedule A, which sets out the parties to be insured, the types of policies to be issued, the amount of insurance coverage, a description of the property being insured and the party currently in title to the property; (ii) Schedule B, which sets out those matters which are shown in the real property records to affect the property and which will be excepted from coverage (the title exceptions); (iii) Schedule C, which sets out all conditions required by the title agency which must be satisfied prior to closing of the transaction and issuance of the title insurance policies; (iv) Schedule D, which discloses the ownership and management of the title agency and the title underwriter and how the policy premiums will be divided; and (v) the title commitment jacket containing the essential terms of the title insurance policy contract and accompanying plain language consumer disclosures.

 

The lender or its attorney will undertake, as part of the loan underwriting due diligence, a review of the title commitment, including (i) a verification that the lender has on file an Insured Closing Service Letter from the title underwriter. In Texas, one letter from a title underwriter addressed to the lender covers all title closings with all title agencies issuing policies with that title underwriter. The form of Insured Closing Service Letter for a lender (Form T-50) is promulgated by TDI and makes the title underwriter responsible for certain losses suffered by the lender for wrongful or negligent acts of the title insurance agency and its employees (including failure to follow written closing instructions, and for fraud and dishonesty in handling funds or documents); (ii) a review of Schedule A of the title commitment to verify the lender is a named insured under the loan policy insured clause, and the amount of the policy; (iii) a review of Schedule B of the commitment to determine the nature and extent of the title exceptions and to order and review the title exceptions documents as necessary to determine that the title exceptions are consistent with the use or intended use by borrower, as owner of the property, and are consistent with loan underwriting title standards as to such issues as access, mineral rights, etc.; (iv) a review and comparison of the title exceptions with a land title survey to ensure that the existing or planned improvements are consistent with the location of existing easements, set-back lines, etc.; (v) a review of Schedule C of the commitment to determine what authority documents are required for closing, what title curative work has been identified and what prior liens or other issues must be resolved prior to closing; and (vi) an assessment of what title policy endorsements will be required by the lender, the availability of such endorsements, and any special conditions to issuance.

This concludes Title Insurance for Lenders- Part I. Stay tuned for Part II- Title Commitment Review, Part III- Title Policies & Endorsements, and Part IV- The Title Company Loan Closing.

New Statutory Home Loan Payoff Statement Forms

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 Starting January 8, 2012, requests from title insurance companies for payoff information from mortgage servicers related to home loans must be given on a new statutory form. The request from the title company must include, at a minimum, the name of the mortgagor, the physical address or legal description of the property, and the proposed closing date of the loan.  Upon receipt of this information, the mortgage servicer must provide the following information in writing:

(1) The proposed closing date;
(2) The payoff amount that is valid through the proposed closing date;
(3) Sufficient information to identify the loan for which the payoff information is provided;
(4) If applicable:
     (a) ARM information
     (b) Per diem amount
     (c) Late charge information
     (d) Escrow disbursement information
(5) A statement stating which party is responsible for the release of lien; and
(6) Any other information necessary to provide a clear and concise payoff statement.

We will be more than happy to provide you with the form in Word