Chapter 9 - § 9.5 • CONSTRUCTION LOAN RISKS: PRIORITY OF LIENS
| Jurisdiction | Colorado |
While any financial institution lending money in Colorado will weigh the risks associated with that lending decision, in the construction arena those risks are more complicated. Lawyers representing such lending institutions should be aware of the special loan risks associated with construction project financing, especially risks concerning the priority of a construction lender's deed of trust lien rights as against the rights of potential lien claimants.
§ 9.5.1-General Rule of Priority
The Colorado mechanics' lien statute38 sets forth the general rules related to "lien priority." Specifically, C.R.S. § 38-22-106(1) provides:
All liens established by virtue of this article shall relate back to the time of the commencement of work under the contract between the owner and the first contractor, or, if said contract is not in writing, then such liens shall relate back to and take effect as of the time of the commencement of the work upon the structure or improvement, and shall have priority over any lien or encumbrance subsequently intervening, or which may have been created prior thereto but which was not then recorded and of which the lienor, under this article, did not have actual notice. Nothing contained in this section, however, shall be construed as impairing any valid encumbrance upon any such land duly made and recorded prior to the signing of such contract or the commencement of work upon such improvements or structure.
Thus, "[m]echanics' liens are generally subordinate to a prior recorded deed of trust on the land."39 However, the practical reality is that construction lenders often find themselves in a junior priority position as against mechanics' lien claimants when it comes time to foreclose on a construction project gone awry.
In general, a construction loan deed of trust takes priority as of the date it is recorded against the subject property. Given the provisions of C.R.S. § 38-22-106(1), however, mechanics' lien claimants take priority as of the date of commencement of work under the contract between the owner and the first contractor, or if said contract is not in writing, then as of the date of the commencement of work upon the structure or improvement by any contractor. This statutory language is commonly referred to as the "relation-back doctrine," and can seriously impact a construction lender's rights relative to the subject property in the event of a foreclosure.40
Should a construction lender need to enforce its rights relative to a construction loan, the key factual determination for establishing the priority of the lender's lien rights is when "work commenced" on the project. Colorado courts have broadly interpreted the language of C.R.S. § 38-22-106(1),41 and have defined "commencement" to mean one of the following: (1) the date upon which an architect or engineer started to work on the preliminary plans and drawings for the project;42 (2) the date upon which materials were first delivered to the project site;43 and (3) the date upon which a surveyor began the initial surveying work on the project.44 As a result of these broad interpretations of the statute (notwithstanding the fact that no active, physical, or visible work has been commenced on the project at the time the construction lender records its deed of trust against the subject property), the construction lender's deed of trust will often be inferior to later-filed mechanics' liens. Those mechanics' liens, under the relation-back doctrine, will have priority dating back to the commencement of first work on the construction project.
The practical impact of the relation-back doctrine is that mechanics' lien claimants will almost always have priority over the construction lender's deed of trust unless mechanics' lien rights have been waived.45 This is so because most construction lenders will not make their lending decisions until after a certain amount of preliminary work on the project has already been completed. Indeed, most construction lenders will require that project plans and specifications, presumably prepared by an architect, be part of the loan application submittals made by the construction borrower. As a result, the mechanics' lien claimant's priority date will almost always predate the construction lender's deed of trust recorded at the time the construction loan is made.
§ 9.5.2-Refinements and Exceptions to General Priority Rule
In certain circumstances, however, the relation-back doctrine has been limited or determined not to defeat a construction lender's priority date. Under these circumstances the construction lender's deed of trust can take priority over a mechanics' lien.
Notice Exception
C.R.S. § 38-22-106(1) provides that...
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