Minnesota Supreme Court decision gives creditors new leverage in mortgage foreclosure sales. (Construction Corner).

The story is a predictable one: Your great relationship with the builder of that fancy home goes sour. As the months pass with no payment on the account, you file a mechanic's lien and bite your fingernails down to nothing. Finally, after all manner of informal persuasion has been exhausted, you discuss with your attorney the need to foreclose the mechanic's lien. You know that there is also a huge construction mortgage recorded against the property, but you eagerly await for your attorney to report that your mechanic's lien has priority over this mortgage.

The report comes back bad. Your attorney informs you that the mortgage was filed before work starred on the property. In fact, the mortgage was filed the very day that the owner took title to the property. Worse than that, the lender had a representative of the title insurance company visit the site on the day the mortgage was filed, and that inspector took photographs of the property showing that no earth was disturbed. The inspector has prepared an affidavit stating that there are absolutely no indications that the lender's priority is threatened.

You sadly write-off yet another debt and watch with envy as the lender forecloses its mortgage, has the property sold to satisfy its mortgage and is able to purchase (and then re-sell) the beautiful house. To accomplish this, the lender pays no cash. It simply bids at the sheriff's sale for the amount of its mortgage, and not a penny more. You shake your head at another travesty of justice and cringe as you consider the conversation with the CFO of your company that awaits you next week when you must inform him of another huge write-off.

The scenario we have just recited is a very familiar one to anyone involved in the credit profession on behalf of subcontractors and suppliers to residential and commercial construction projects. Lenders and their allies appear to be gaining greater and greater success in successfully lobbying for laws that increase lenders' likelihood of priority on construction projects and correspondingly decrease the likelihood of priority for the liens of suppliers and contractors.

However, a potentially explosive exception to these lender priority trends has appeared from the Minnesota Supreme Court. In a unanimous decision issued on March 7, 2002, the Court awarded a residential lumber supplier, Shaw/Stewart Lumber Company, a money judgment for the lumber company's entire mechanic's lien, directly against a lender, a lender that had issued a construction mortgage on the property that--at first glance--had appeared to have clear priority over the mechanic's lien.

Here is what happened. The lender had filed its mortgage and obtained the usual photographs and affidavits showing that the dirt was nor disturbed on the property prior to the filing of the mortgage. As with most construction loans, the terms of the loan provided that the loan amount would be disbursed over time, as the construction progressed. The project went bad, and the lender foreclosed its mortgage. At the sheriff's mortgage foreclosure sale, the lender made the standard bid for 100 percent of its mortgage debt, and money did nor actually change hands. The lender then won the bid at the sheriff's sale and took title to the property.

However, the lumber company did not turn rail and give up on its lien. Instead, it alleged that even though the lender had priority for some of its loan proceeds, the loan proceeds disbursed by the lender after work started was inferior in priority to the mechanic's lien. The lumber company took this position because the lender could point to no language in its loan documents that contractually obligated the lender to disburse 100 percent of the loan proceeds. Based upon this theory, the lumber company directly sued the lender and alleged that because of the lender's "split priority," the ...