STANLEY RAGALEVSKY
Banks can protect themselves
Securing a construction loan from a Massachusetts bank may have just become more complicated. A recent court decision has the lending industry, particularly banks, on edge because in order to protect themselves, banks may have to request a subordination agreement from builders before agreeing to finance a loan.
The Massachusetts Supreme Judicial Court denied further appellate review in the Queeno v. Colonial Co-operative Bank case in July after the Massachusetts Appeals Court issued its decision in the case in May, finding in favor of the plaintiffs and putting a mortgage behind a purchase and sales agreement in the priority pecking order.
“This court concluded that an unrecorded purchase and sales agreement had priority over a recorded bank mortgage in the chain of title to the property that was the subject of both the mortgage and the agreement, where the bank had actual notice of the agreement and its details prior to its issuance of the mortgage, and where the plaintiffs, by virtue of the agreement, had acquired and equitable interest in the land,” the court’s decision read. Opponents have said the decision could create problems, such as difficulty for builders to secure construction financing for a new home.
Colonial Co-operative, based in Gardner, appealed the decision to the Supreme Judicial Court. In June, the Massachusetts Bankers Association, which represents more than 200 banks in the Bay State, sent a letter to the SJC justices arguing for further appellate review, at which time the SJC took no action. But in July, the SJC, which needs three justices to say if the case is significant to be heard, denied a motion for further appellate review.
Because of that decision, attorneys are warning banks to add another step to their construction lending process. Sean Mahoney and Stanley Ragalevsky, attorneys at the Boston-based law firm Kirkpatrick & Lockhart Nicholson Graham, said the best way for banks to protect themselves is to add a signed subordination agreement to their required documents.
The Appeals Court either found that the execution of a purchase and sale is the “conveyance of an estate” subject to Massachusetts law or that equitable principles required that the bank’s mortgage be subject to the purchase and sales agreement, Ragalevsky said.
“The odd thing about applying such equitable principles here is that all of the parties must have intended that the developer would obtain financing to build the dwelling,” he said.
Ragalevsky said the bank may want to require builders to obtain signed subordination agreements when the purchase and sales agreement is signed because the Appeals Court has determined a recorded mortgage lien can be “subject to” an unrecorded “interest in real estate.” Developers may now get buyers to agree in a purchase and sales pact that the agreement is subordinate to the construction financing, he said.
“Subordination agreements should be included in the bank’s checklist for ‘presold’ construction loans and bridge loans,” Mahoney said.
Ragalevsky said the Appeals Court suggested in its dictum that the bank could have protected itself with a subordination agreement.
“Applying the dictum in the Queeno case, a lender will be in the best position if it has a signed subordination agreement by the buyer of real estate in a situation where the purchase and sales agreement between the contractor/seller and the buyer predates the construction loan,” Ragalevsky said.
More Paperwork
Although banks may have to include subordination agreements in their paperwork in order to prevent a similar situation from happening, Ragalevsky said the agreements between a lender and a contract buyer should not be recorded.
“You generally wouldn’t want to record these because the party giving subordination doesn’t have a record interest in the real estate,” Ragalevsky said.
According to Blake Godbout, attorney for Colonial Co-operative Bank, the case is going back to the Massachusetts Superior Court for separate matters related to the case.
As a precaution, Godbout said the bank is addressing the subordination agreement problem by drafting a form for future construction and bridge loans. He acknowledged that creditors will do what is necessary to protect their business; however, that does not come without a price.
“It adds to the cost,” Godbout said.
Ragalevsky and Mahoney said, at the very least, other banks should think about drafting a similar form to incorporate into the lending process.
“Every bank should review this case with legal counsel to determine the appropriate course of action,” Ragalevsky said.
Henry H. Thayer, partner at Boston-based Rackemann, Sawyer & Brewster and chairman of the joint Real Estate Bar Association/Abstract Club Amicus Brief Committee, said banks will have to get used to an additional form.
“We never used to do this,” Thayer said. “[It is] one more piece of paper.”
Thayer said banks can easily create an in-house subordination agreement form. However, he said he suspects that REBA’s Forms Committee will come out with a suggested form in the near future.
Mahoney said the question of whether there should be a standard subordination agreement form is a global one.
“Sometimes standardized forms are appropriate and other times they are not,” Mahoney said. “In this context a standardized form likely would be helpful, but this could come from vendors or from banks sharing forms. The important thing is for developers and real estate brokers to be prepared to ask buyers for subordination agreements on presold construction and bridge loans. As this becomes part of the process, everyone should get used to it.”
Ragalevsky said some might view the fact pattern in the Queeno case as a limited situation, but he said he still believes it is a good idea for a bank financing the construction of a presold dwelling to obtain a subordination agreement from the contract buyer as a precaution.
