News and Events
Lender Alert: Washington Supreme Court Calls into Question the Priority of Certain Real Estate Secured Advances
One of the foundational principles of lien priority is the maxim “first in time, first in right.” Based on this long-held presumption, bolstered by Washington’s lien statute (RCW 60.04.226), lenders and lawyers in Washington have assumed that all subsequent advances secured by a first-in-time deed of trust had priority over any subsequent-in-time liens. In its recent decision Commencement Bank v. Epic Solutions, Inc. (In re EM Property Holdings, LLC), the Washington Supreme Court held that Washington’s lien priority statute applies only to advances of construction loan proceeds, and that the priority of non-construction loan advances is instead governed by Washington common law that historically distinguished between two types of advances: optional advances and obligatory advances. Under this distinction, Commencement Bank suggested that obligatory advances maintain priority over intervening liens, while optional advances may lose priority over intervening liens depending on the facts and circumstances.
For lenders with non-construction loans secured by real estate in Washington, the Commencement Bank decision raises significant questions and concerns about the priority of future advances over intervening liens. As news of this decision has spread throughout the lender industry, we’ve fielded numerous questions about the impact of the Commencement Bank decision on outstanding and future non-construction loans alike. The most common questions are as follows:
What makes an advance “optional” vs “obligatory”?
Under the Commencement Bank decision, the crux of whether a future advance retains priority over an intervening lien turns on whether the advance was “optional” or “obligatory” under the loan documents. The Commencement Bank court, however, did not provide much guidance as to what constitutes an optional advance versus an obligatory advance except to note that “if a mortgage secures future advances that the mortgagee is not obligated to make – and thus are optional – any future advances are subordinated to any intervening encumbrance[.]”. We read the Commencement Bank decision to suggest that any time a future advance is within the discretion of the lender, that future advance is likely deemed optional, but exactly how to determine when discretion is involved is far from clear, and the case law on this issue that predated that lien statute is ambiguous at best.
Am I protected by a statement in my deed of trust that the instrument secures all such future advances? Isn’t that sufficient to put subsequent lienholders on notice?
The Commencement Bank decision suggests that, for non-construction loans, the mere inclusion of customary language that the instrument secures all future advances is insufficient, by itself, to definitively determine lien priority with respect to such advances. Instead, the Court found that courts must evaluate whether subsequent advances were obligatory or optional to determine priority. According to the Court, a security instrument noting it covers all future advances does not provide sufficient notice of the total potential liability if future advances under the instrument are optional.
What should I do to ensure subsequent advances retain priority?
For construction loans, the Commencement Bank decision affirmed that the priority of subsequent advances is governed by the Washington priority statute (RCW 60.04.226), thereby granting subsequent advances of construction loan proceeds priority over any intervening liens. No further action should be required except obtaining the standard date-down endorsement showing no intervening liens that lenders routinely receive on subsequent advances of construction loan proceeds.
For existing non-construction loans, prior to making any subsequent advance, we strongly recommend you consult with the title company insuring the loan to determine what information the title company might need to provide a date-down endorsement to the policy in light of the Commencement Bank decision. We suspect that owner’s affidavits, focused on any intervening work that may have been undertaken or is ongoing at the property, will become much more common deliverables for any subsequent draw requests of non-construction loan proceeds. Other actions that may be advisable depending on the circumstances include negotiating priority and subordination agreements with any known intervening lienholders.
For new non-construction loans, we recommend that you evaluate with your legal counsel whether any language that might be interpreted to make subsequent advances discretionary under the loan documents remains advisable in light of the Commencement Bank decision. Although it may be desirable for a lender to retain the discretion to make subsequent advances to protect the interests of the lender, the benefit of such discretion will need to be balanced against the risk that an intervening lienholder could assert priority as to the proceeds of any advances by the lender subsequent to the junior lienholder’s claim.
This decision feels disruptive to established lending practice. What can be done?
As an historical observation, we note that the current Washington priority statute (RCW 60.04.226) was a legislative response to a Washington Supreme Court decision that came to a similar conclusion in the construction loan context. We believe the Commencement Bank decision warrants a similar legislative response and strongly encourage lender-focused advocacy groups and other interested parties to work with their legislative contacts to investigate how best to expand the applicability of the protections of RCW 60.04.226 to all commercial loans.
For more information, please do not hesitate to contact the HCMP attorneys who contributed to this update:
The information contained in this update is provided for informational purposes only. It is not business, legal, accounting, tax, financial, investment or other advice on any matter and may not be relied upon as such. Please contact your attorney to obtain advice regarding any particular legal matter.