Parties to a foreclosure sale often believe that the foreclosure of a deed of trust lien eliminates all liens encumbering the property and provides the purchaser with title to the property free and clear of all liens and encumbrances. In Texas, this is not always the case.
The remedy of foreclosure is available to lenders in the event of a borrower’s default on a loan secured by real property. Foreclosures may be judicial (ordered by a court following a judgment in a lawsuit) or, most likely in Texas, non-judicial (“on the courthouse steps”). The effect of foreclosure is to cut off and eliminate junior liens, including mechanic’s liens, except for any liens for unpaid taxes.
“A valid foreclosure on a senior lien (sometimes referred to as a ‘superior’ lien) extinguishes a junior lien (sometimes referred to as ‘inferior’ or ‘subordinate’) if there are not sufficient excess proceeds from the foreclosure sale to satisfy the junior lien. . .. In general, mechanics’ liens with an inception date that is subsequent to the date of a deed-of-trust lien will be subordinate to the deed-of-trust lien.” Trinity Drywall Systems, LLC v. TOKA General Contractors, Ltd., 416 S.W.3d 201 (Tex.App.—El Paso 2013, no pet.). However, a perfected mechanic’s lien is deemed to “relate back” in time to the date of its inception. Therefore, even though a mechanic’s lien may not be filed until many months after work is commenced, the relative priority date for the mechanic’s lien relates back to the date of the commencement of the visible work. Diversified Mortg. Inv’rs v. Lloyd D. Blaylock Gen. Contractor, Inc., 576 S.W.2d 794, 803 (Tex. 1978). If the project has a notice of commencement or affidavit of commencement filed, the lien would relate back to, and would be considered “created”, upon the date of filing. It is worth noting that the filing of a notice of commencement is optional in Texas, while in some states, such as Florida, it is required by law.
In the absence of a filed notice of commencement, the Court in Diversified Mortgage described the following factors to consider when determining if the commencement of construction on the land is sufficient to constitute the inception of the lien: (i) if the construction activity is conducted on the land itself, (ii) if the activity is visible upon the land, and (iii) if the activity constitutes either (a) an activity which is defined as an “improvement” under Texas statute or (b) the excavation for the laying of the foundation of a building or a structure. 576 S.W.2d at 802. However, the clearing of a construction site is not sufficient to constitute commencement of construction for inception purposes. See Perkins Constr. Co. v. Ten-Fifteen Corp., 545 S.W.2d 494, 499 (Tex. Civ. App.—San Antonio 1976, no writ).
Because commencement of construction on a property may be deemed to occur before the lender extended the foreclosed upon loan as a result of the “relation back doctrine,” the new owner of the foreclosed property (whether it be the lender or a third party purchaser) may be surprised to discover later on – often when they want to sell or re-finance the property – that it is encumbered by one or more mechanic’s liens that were not extinguished by the foreclosure.
For this reason, it is important to thoroughly conduct due diligence before purchasing property at a foreclosure sale in order to minimize the risk of taking title subject to stray mechanics’ liens and other issues that cloud title. It is recommended that a prospective purchaser obtain a title report and copies of the warranty deed and any deeds of trust or other lien instruments affecting the property. Further, it may be prudent to contact the trustee named in the notice of sale and ask them to provide any additional information regarding the property that could not be obtained by other means.
If you have done your due diligence on the front-end and the title company informs you that your foreclosure property is encumbered by a mechanic’s lien, you can attempt to have the lien removed as an exception to the title commitment in several ways.
The simplest way would be to simply wait for the applicable statute of limitations to foreclose on the lien to expire before selling or refinancing the property. While the applicable statutes allow lienholders to foreclose within two years of the accrual of the lien claim on a commercial project or within one year of the accrual of the claim on a residential project, a constitutional mechanic’s lien, granted to original contractors (i.e., contractors that contract directly with the property owner) under the Texas Constitution, has a four year statute of limitations and arises by implication, meaning the lien claimant doesn’t even have to file a lien affidavit to claim a valid lien.
If waiting is not an option, you can request that the title company “insure around” the lien by (i) attacking the validity of the lien directly (i.e., the lien affidavit is deficient, the lien was not timely filed, or certain parties were not properly noticed), (ii) providing evidence that the foreclosed upon lien was superior and was filed prior to the date of inception of the mechanic’s lien in question (i.e., by providing the title company with a previously filed notice or affidavit of commencement), (iii) proving that the statute of limitations for foreclosing on the mechanic’s lien has run, or (iv) proving that you were a bona-fide purchaser. A third party buyer purchasing property at a foreclosure sale has the benefit of being treated as a bona-fide purchaser in the event such purchaser acquired the property in good faith, for value, and without notice (constructive or actual), of any third party claim or interest. A purchaser has actual knowledge if it knew of the general contractor’s recent work or lien claim, or where the purchaser might, by reasonable diligence, have informed itself of the existence of certain facts. Constructive notice of a mechanic’s lien requires that the lien be filed in accordance with the statutory requirements, including timelines. However, because status as a bona fide purchaser is an affirmative defense, a title company may not “insure around” the lien absent an actual title dispute.
If the title company refuses to remove the lien, if applicable, you can demand that the claimant remove the lien on the grounds that the lien is invalid or defective for any reason described above and inform them of the foreclosure. If the claimant does not respond or otherwise fails to execute a release of lien, Section 53.160 of the Texas Property Code allows a property owner to file a “Summary Motion to Remove Invalid or Unenforceable Lien” which allows for the removal of the lien as quickly as twenty-one days from the date the claimant answers or appears in the suit. Alternatively, you can file a bond under Section 53.171 of the Texas Property Code to indemnify against the lien.
Taking title to foreclosure property can be a risk for many reasons. Do not assume that the foreclosure proceeding resolves all potential title issues. If possible, conduct due diligence before purchasing a piece of foreclosure property. If a mechanic’s lien issue arises after the foreclosure proceeding, don’t panic and contact a licensed real estate attorney to discuss your options regarding the lien.