The scenario of a developer who paid cash for a parcel of land and wants to get started on development and construction prior to the closing of the construction loan is fairly common. However, under Ohio law a pre-start construction project creates difficulties for the title insurance underwriter to insure the priority of the mortgage over mechanic’s lien risk. This is likely to result in more time and costs to provide the required title insurance and if not handled properly, it could jeopardize the financing for the project. Following is a brief summary of some of the title insurance considerations that should be addressed:
Mitigating the Risk
While it is my recommendation that the owner withhold all development and construction activities until after the financing is in place and the mortgage is filed, I recognize that in some cases this cannot be helped. Following are my suggestions if a pre-start cannot be avoided:
A. Have a plan in place with the title underwriter so there are no surprises. I recommend that you have as much of the underwriting completed prior to signing any of the construction contracts. In other words, communicate the plan and obtain the pre-approval of the title underwriter. For example, if the title company is being asked to rely on a mechanic’s lien indemnity, the personal financial statements of the signatories should be pre-approved.
B. Do not record a Notice of Commencement (“NOC”) prior to the closing or filing of the mortgage to be insured. This is vital. Recording the NOC before the mortgage will result in the mortgage losing its priority to any and all mechanics’ liens no matter when the work is performed, even if such work occurs after the filing of the mortgage. This point should also be emphasized to all general contractors, because in some instances a contractor will file the Notice of Commencement directly. The NOC should be filed immediately after the filing of the mortgage. Once it is filed, the lien priority for all future work performed will refer back to the date and time of the filing of the NOC.
C. Strong Personal Financial Statements by the signatories of the Mechanic’s Lien Indemnity will help solve many of the underwriter’s concerns. A good track record will also help. If the financials are not solid, the underwriter might reject the application for coverage or insist on a funded indemnity. Under a funded indemnity, either the actual funds will be set aside in a special account, or a letter of credit will be established for the title insurance company to unilaterally draw upon if a mechanic’s lien(s) is filed.
D. Bifurcate the Construction Contracts such that all (or most) of the pre-closing construction activities are built into a separate construction contract. This step can significantly limit the risk for the title underwriter.
The title insurer may require copies of some or all of the following documentation in order to assess and minimize the risk. The items listed below are an estimate of what the underwriter will require. If the underwriter is willing to assume the risk, the final list of requirements may vary based on the specific circumstances of the transaction.
1. Tax Returns for last two (2) years;
2. Balance Sheet;
3. Profit/Loss Statement;
4. Construction Contract;
5. Construction Budget;
6. Construction Loan Agreement;
7. Appraisal showing estimated value of the completed project;
8. Source of Funds for the pre-start work;
9. Personal Guaranties;
10. Mechanic’s Lien Indemnity(ies) from the Borrower, and any individuals whose financials were approved;
11. General Contractor’s Affidavit stating that all contractors have been paid through a certain date and identifying each and every contractor who has performed work or delivered materials through the date of closing;
12. Lien Waivers from all contractors who have been on site performing work or delivering materials through the date of closing; and
13. Affidavit of Completion for any construction contracts that are fulfilled prior to the loan closing.
In addition, the title agent is required to submit a Mechanic’s Lien Risk Assessment document to the underwriter, which could result in more questions and document requests.
Additional Title Premium
If the title underwriter perceives a “Loss of Priority” of the insured mortgage to potential mechanic’s liens, it may require an additional premium of 40% of the full Loan Policy premium. As of 2013, providing such mechanic’s lien coverage is now a filed rate with the Ohio Department of Insurance.
Should you have any questions, please contact the author of this post, Greg Haverkamp, President of Riverbend Commercial Title Agency at (513) 579-6453; firstname.lastname@example.org
This blog post is authored by Greg Haverkamp, President of Riverbend Commercial Title Agency, which is a wholly-owned subsidiary of Keating Muething & Klekamp PLL. Greg Haverkamp is not an attorney and is not giving or attempting to give legal advice. Please consult with counsel of your choice regarding any specific questions you may have.
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