Using Title Insurance to Mitigate Risk Created by Mechanic’s Liens

Colorado law allows contractors and subcontractors that supply labor or materials to a property to file a lien against that property, securing payment for the materials and services that they provided.  The theory is that the contractors have enhanced the value of the property, which is why they are permitted to hold a lien against the property until they are paid in full.

The Risk: Relation Back

Although a contractor is not permitted to file a lien until after they have completed their work, the statute allows a properly filed mechanic’s lien to take priority over any other lien that was recorded after commencement of the project through the concept of “relation back”.  Even if a mechanic’s lien is for work that was performed at the very end of a construction project, the lien attaches to the property as though it was recorded at the time that the project commenced.  Unlike in some neighboring states, the “commencement of work” standard in Colorado is not the first “shovel in the ground.”  Rather, in Colorado the work commences with the initial planning and architectural drawings that are often needed to obtain financing for the project.

The practical reality is that it is nearly impossible for a construction loan to take priority over a properly filed and recorded mechanic’s lien in Colorado, regardless of whether the contractor filing the lien is the first or the last contractor on the job.  Because contractors are permitted to record liens as late as six months following the completion of their work, there is risk to a lender that a mechanic’s lien claimant could file a lien well after the recording of the deed of trust securing the construction loan; because of the “relation back”, the lien could take priority over the construction loan.  Mechanic’s liens are essentially “secret” liens that can destroy the priority of construction loans and other interest-holders.

The Solution: Title Insurance

Title insurers offer products that insure against loss of priority due to the post-closing filing of mechanic’s liens.  However, when a title insurer is deciding whether to insure a construction lender against mechanic’s liens in Colorado, it must assume that there is a loss of priority due to relation back.  Therefore, providing mechanic’s lien coverage in Colorado is always risky, and insuring over that risk generally comes with additional cost and title requirements.

Generally, title insurance policies do not provide coverage for any matters that are first recorded after the policy is issued.  However, mechanic’s liens are different.  ALTA Loan policies can provide coverage for mechanic’s liens that are recorded after the issuance of the policy, if the work was performed or contracted for prior to the date of the policy, or, if some portion of the loaned funds were used to finance the construction.

The simplest way to obtain coverage for future mechanic’s lien issues is to request the deletion of Standard Exception Number 4, which excepts from coverage losses arising from mechanic’s liens.  However, removal of this exception for a construction loan carries with it significant risk for a title insurer.  Therefore, in lieu of deleting Standard Exception Number 4, a title company may offer a series of endorsements that create more tailored coverage for mechanic’s lien losses.

Specific Endorsements

The 101.5 endorsement provides coverage for work and materials supplied up to the date of the policy.  This gives the construction lender coverage for liens that may arise due to work or materials supplied prior to the recording of the deed of trust.  Once the policy is issued, the lender controls the disbursement of the construction funds, and assumes liability for mechanic’s liens arising due to labor or materials supplied after the date of the closing.  If the lender would prefer that the title company handle the loan disbursements through its Construction Disbursement Department, a 101 endorsement may be available, which will provide the lender with coverage for mechanic’s liens that arise, but for which payment has been made with funds disbursed by the title company.  The ALTA 33 endorsement provides incremental coverage for mechanic’s liens arising from materials and services provided prior to a date defined in the endorsement.  This endorsement provides coverage forward with each draw date.

Work with your title company in advance to determine which endorsement package is the best fit for your project, and to find out what requirements the title company will make to provide the selected endorsements.  Given the increased risk involved in insuring over these “secret liens”, title companies may require the production of lien waivers and/or financials.  The risk of loss due to a large mechanic’s lien could be devastating to a commercial project; the benefits that the title policy can provide through appropriate deletions and endorsements is invaluable.