What is a Lien?
A lien is a legal right, usually referred to as a security interest, in real or personal property given to a creditor to hold and possess as consideration for a loan. The creditor/lender has a charging interest against the collateral and may seek possession in the event of default by the borrower. A borrower willfully grants the security interest in real property by agreeing to sign an instrument called a deed of trust or mortgage which is recorded in public records as an encumbrance to the real property in consideration for the loan. A lien refers to a monetary claim which may be attached to one or more properties.
What is an Encumbrance?
An encumbrance refers to a claim and/or agreement to enforce the rights and obligations relating to a property. There are literally dozens of items that may be recorded in public records that create either a lien or an encumbrance on the property. The first will be the original tract map. Then comes utility easements, other easements, government mandated requirements such as historical registries, association by-laws, ownership and partnership agreements, and tenancy leases; various public notices such as notice of weed abatement, notices of a substandard condition, lis pendens, property settlements, divorce decrees, subordination, non-disturbance and attornment agreements (commonly abbreviated as an “SNDA agreement”) parking easements, reciprocal usage and parking agreements, signage easements, property tax, federal or state tax liens. etc.
The lending industry sometimes uses the terms lien and encumbrance interchangeably. However, a lien is a monetary charge against the property. All liens are encumbrances, but not all encumbrances are liens. They both create a claim against the property that impacts the transfer-ability and restricts the free use until the claim is lifted or is conveyed.
How does an attachment to a property occur?
In the United States, we have a standardized government records system referred to as the municipal recorder’s office. The recorder’s office has the task of maintaining public records and documents relating to real estate ownership. Their task includes recording and maintaining records, making those records available and identifiable to the public. Those public records can relate to both voluntary and involuntary rights and claims.
Liens and encumbrances create clouds on the title that must be dealt with, either by accepting the property with the conditions, removing them from the title, modifying, or rejecting the property because the risk is too great.
Each document recorded against the property may contain agreements, considerations, prohibitions, and risks that must be dealt with. A recorded trust deed may have 20-40 pages of legalese that need to be reviewed by the borrower and the prudent lender. The document may contain clauses such as a “due-on-sale”, “due-on-further encumbrance,”. The subject relating to various clauses in loan documents which generally create prohibitions should be addressed in another article because of their tremendous complexity.
Sometimes a property owner may record changes that amend ownership status. An example would be changing or conveying the title of a property from “husband and wife as joint tenants” to a “revocable family trust”. Another example may be the recording of a divorce decree or a quit claim relinquishing one’s interest in the property.
What is a first, second and third lien priority?
Lien priority is related to the point in time that the document is recorded in the public records office. When a document is recorded, it is date-stamped and given a sequential recording reference number. If a borrower or his/her title company recorded 3 liens at the same time on one property, that would create a first, second, and third lien, regardless of the dollar amount of each lien. The first lien is considered a senior lien, the second and third liens are junior liens, with the second lien being senior to the third. After the documents are recorded and scanned into the public records computers, the lender or borrower will receive the original documents back for safe keeping.
What ensures the order of the recording? How do you know that the recorder did not make a mistake and record the documents out of order? You may order and pay for an insurance policy referred to as title insurance from an insurance carrier. The policy guarantee’s your lien priority position or the carrier may be required to pay an insured claim. If you were to go to the recorder’s office, stand in line, and have the documents recorded you could check the sequence of recording yourself. But, generally, the recording of documents is done by a title company in relation to a sale or loan transaction in which you as the lender are a party or represent a principal party.
Let’s assume that there was a first lien of $100,000, a second lien of $50,000, and a third lien of $25,000. on a property you own. If you paid off the first lien and had the lien reconveyed off public records, the second would become a first lien, and the third would become a second lien. If you were to refinance and merge all three liens, then all three liens would be reconveyed and removed off public records. A new recording, with a fresh date stamp and recording number, would be placed on public records reflecting a new first lien position. A reconveyance is a written form instructing the recorder to remove and release the lien from public records.
There are written agreements that can be created by principal parties that modify the priority of a lien, or multiple liens. One is called a subordination agreement that can be recorded that may make a lien junior to another lien even though it was recorded earlier with an earlier date stamp.
California law regards lien priority as “first-in-time, first-in- right”. California law also provides for exceptions for some types of liens whereby some liens are given “skipping power” to the front of the line. Government mandate permits certain liens to be advanced, so they become the senior in priority to other liens. Mechanic’s liens, meant to ensure that tradesmen and contractors are paid, is an example of a priority lien with “skipping power”. That right is protected by the California Constitution and further enumerated in the California Civil Code (Section 3110 et seq.)
There are limits, however, on the “skipping power” of mechanic’s liens. These relate to technical requirements such as when the construction began and the process that the claimant must follow to enforce that lien. Even in situations where the mechanic’s lien appears to have been “wiped out” by a senior lienholder at a foreclosure sale, the lien is not automatically expunged. For more specific requirements for mechanic’s liens, the lender should work with counsel knowledgeable about construction and mechanics lien law.
Other exceptions relating to “skipping power” may include issues relating to property taxes, special tax assessment districts, and sometimes homeowner’s or mutual property associations.
A written tenancy agreement has “first-in-time, first-in right” priority. Tenants who have written agreements with dates prior to the recording of a new trust deed will have a right of occupancy and enforcement senior to the new lien. The tenant’s rights will run with the property until the rights expire or are changed in writing.
A real estate lender may require modification of the statutory priority by using a written agreement between the borrower, the tenant, and the lender. Sometimes it is in the lender’s best interest not to preserve the tenancy in which case a straight subordination may be used. Any change in the chain of title, whether it is a sale, a new loan or a foreclosure, can cause the priority of tenancy to be lost.
Sometimes, the lender may wish to preserve the tenancy of credit tenants to preserve the value of the property. A subordination, non-disturbance and attornment agreement (“SNDA agreement”) may be the appropriate document to have recorded. SDNAs are agreements between a tenant and a landlord that lays out certain rights of the tenant, the landlord, and other third parties, such as the landlord’s lender or a purchaser of the property.
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