Pub. 12 2015 Issue 3

O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S - H E L P I N G N E W M E X I C O R E A L I Z E D R E A M S Fall • 2015 17 While these changes were adopted effective August 2014, many lenders are only just beginning to realize the impact of these changes, especially with construction loans under “bro- ken-priority” conditions or very large construction loans even with clean priority. Particularly with the use of the new ALTA mechanics’ lien coverage endorsements for construction loans, banks need to understand new requirements and coverage lim- itations - and may need a greater level of control for disbursing loan proceeds and need closer construction supervision. I. Construction Loan v. Permanent Loan Policy Coverage The separate, two year construction loan policy (former NM 3) has been eliminated. Instead, the loan policy will have either: a) permanent coverage for at least the life of the loan, or b) a two (2) year claims made limitation exception. 1 The two year expiring construction coverage has the same price structure as the prior construction policy, which is substantially less than permanent coverage. The premium for $1million of expiring (construction) coverage is $1,030 ($30 plus $1 per thousand of insurance coverage), while the same $1million of permanent coverage is $4,268. The prior option to buy four (4) extension endorsements (NM 11 Multipurpose endorsement of 6 months each, $25 per extension) is still available to add two (2) years of policy coverage for an expiring policy. However, a policy issued with an expiration cannot be converted to permanent coverage. By comparison, a standard permanent loan policy has no time expiration. 2 The lender must elect at the time the loan policy is issued, whether the bank will accept a cheaper expiring policy or re- quire the more expensive permanent loan policy. NM lenders should be careful not to allow the cheaper expiring (construc- tion purpose) coverage for “convert-to-term” loans including construction-to-term and advancing-to-term loans. There is also the risk of loss of coverage when an expiring policy is used for a bridge, short term, or construction loan, the loan has mul- tiple renewals, and then converts into an extended workout or foreclosure. Coverage under a loan policy continues to insure the lender after acquisition of title to the property is obtained by the bank through such processes as foreclosure, trustee’s sale, or conveyance in lieu. (NM 2, Conditions, 2. Continuation of Insurance). Keep in mind the workouts and foreclosures often occur after multiple renewal efforts and may not be resolved until many years after the loan policy is issued. Purchasing the four (4) extension endorsements for the two (2) year policy can only give that expiring policy a maximum four (4) year life, af- ter which the policy coverage has expired and the bank may be forced to buy a new permanent loan or owner’s policy. II. Mechanics Lien Coverage NM has now adopted the current ALTA 32 series construc- tion loan mechanics’ lien endorsements. The title company has the discretion to determine, on a case-by-case basis, which en- dorsement version it will require. Standard total mechanics lien coverage for the entire con- struction loan is still available. Some title underwriters will grant this total mechanics’ lien coverage for residential and smaller commercial loans with evidence of clean lender’s lien priority over mechanics’ liens. For larger commercial loans, or in the event of a broken priority, title companies have the right to impose severe limits on mechanics’ lien coverage by using the NM 83, 83.1 or 83.2 (ALTA 32-06, 32.1-06 or 32.2-06) con- struction loan endorsements with more limited pending dis- bursement endorsement protections in amount of mechanics’ lien coverage and dates of coverage. The Broken Lien Priority. In New Mexico, the contractor and all subs and suppliers have the same lien priority; back to the date work was first performed on the site. 3 By ensuring the lender’s mortgage was recorded prior to the first work done at the project site, the lender could historically require and receive total coverage against mechanics’ lien claims made by any un- paid contractor, sub or supplier by having the borrower pay for that coverage. This total mechanics’ lien coverage for the en- tire construction loan is provided by deleting Standard Excep- tion No. 4 (mechanics’ lien exception) from Schedule B for $25 with a pending disbursement exception and NM 22 Pending Disbursement Down Date endorsements for each construction loan draw at $25 per endorsement. Title companies have always had the right to manage the risk of a broken lien priority by underwriting the risk and having the right to decline to cover mechanics liens. If total mechanics’ lien coverage was written, in addition to the significant cost of the extra-hazardous premium for broken priority coverage [$5 per thousand of the amount of the loan policy which is five times the total premium of a time limited loan policy]. The title company can also require the owner and general contractor to indemnify against claims, require that the indemnity be secured by collat- eral, and require additional construction project and payment documentation. While this option is still available to the title company, lenders and banking attorneys are finding the title companies are increasingly less willing to undertake this form of risk, particularly on large and/or un-bonded projects. Additionally, the title company now has the ability to further manage its mechanics’ lien risks on larger projects where the mortgage is clearly recorded prior to start of construction, by limiting mechanics’ lien coverage by the use of the NM 83 series construction loan endorsements. Basically, these construction loan endorsements provide me- chanics’ lien coverage limited by: (1) time (Date of Coverage), and (2) amounts of mechanics’ lien coverage (Aggregate Amount).  Lien Times  continued on page 18 The two year expiring construction coverage has the same price structure as the prior construction policy, which is substantially less than permanent coverage.