Liens and Encumbrances Affecting Real Property
By Dan Harkey
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 a real property by agreeing to sign instruments called a deed of trust or mortgage which are 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 leases; various public notices such as notice of weed abatement, notices of substandard condition, lis pendens, property settlements, divorce decrees, subordination, non-disturbance and attornment agreement (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 transferability 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 government system referred to as the municipal recorder’s office. The recorder’s office has the task of maintaining public records, documents; and in this case, relating to real estate ownership. Additionally, 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.
Each of the above creates a cloud on title that must be dealt with, either accepting to property with the conditions or clouds, removing from title, releasing, modifying, or rejecting the property because the risk of accepting all the conditions is go great or not practical.
Each document that is recorded on the property may also contains an agreement, considerations, prohibitions, and risk that must be dealt with. A recorded trust deed may have 20-40 pages of legalese that need to be reviewed. The document may contain clauses such as “due-on-sale”, “due-on-further encumbrance,” etc. This subject relating to clauses in loan documents should be addressed in another article, because of its tremendous complexity.
Sometimes a property owner may record changes in amends 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.
This body of knowledge and law and the process of recording and maintaining the documents becomes very important when establishing the priority of a lien or encumbrance. California law regards lien priority as “first-in-time, first-in- right”.
What is a first, second and third lien priority?
Lien priority is related to the point of 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 borrower will receive the original documents back for safe keeping.
What insures 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 a title insurance carrier. The policy guarantee’s your lien priority position or may be required to pay insured claim. If you were to go to the recorder’s office yourself, stand in line, and have the documents recorded you could check the sequence of recording yourself. But, generally your recording of documents is done by a title company in relation to a sale or loan transaction in which you are 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 that you own. If you paid off the first lien, the second would become a first lien, and the third would become a second lien. If you were to refinance and consolidate 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 that they become 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 lien holder 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 law and mechanics lien law.
Other exceptions relating to “skipping power” may include issues relating to property taxes, special tax assessment districts, and in some cases homeowner’s or mutual property associations.
As a rule, 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 that is senior to the new lien. The tenant’s rights will run with the property until the rights expire or are modified in writing.
A real estate lender may require some modification of the statutory priority by using a written agreement between the borrower, the tenant, and of course, the lender. There are times where it may be 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.
In some cases, the lender may wish to preserve the tenancy of credit tenants in order 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 our certain rights of the tenant, the landlord, and other third parties, such as the landlord’s lender or a purchaser of the property.
If I can answer questions or I refer you to good service providers, I am only a phone call away. Please visit my web site www.danharkey.com to read more of my articles related business, real estate finance, and humor & prospective.
Thank You!
Dan Harkey
Business and Private Money Finance Consultant
Bus. 949 521 7115
Cell 949 533 8315
The article is for educational purposes only and is not intended as a solicitation
