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Construction Law Today

Construction Mortgage Foreclosure Does Not Wipe Out Reciprocal Easement Agreement Rights: Bank of America v. Cannonball

Posted in Construction Finance and Insolvency, Illinois, Mechanics Liens, States, Uncategorized

A foreclosing construction lender recently tried to wipe out liens securing debt under a shopping center cross-use and easement agreement. The Illinois Appellate Court denied that attempt. The decision: Bank of America v. Cannonball LLC.

Backstory

It starts with a new shopping center with a Home Depot, a Kohl’s, and a Target. The local village subsidizes part of the developer’s construction cost. To fund that subsidy, the village sells bonds to investors. And to raise money to service the debt owed under those bonds, the village imposes a special service area tax on the businesses that sell goods and services in the shopping center. (The tax obliges those businesses to collect a surcharge on each sale to pay the tax).

The developer also divides-up the shopping center, selling some parts to business operating there, and keeping other parts (e.g., parking, other common areas). In that process, the developer and Home Depot enter into a purchase contract and an operating and easement agreement (that they call an “OEA”). The OEA governs use and operation of common areas sharing the operating costs. Among the features in these two contracts:

  • The developer’s promise to reimburse Home Depot for part of the tax payments Home Depot must collect and remit to the village
  • A grant to the Home Depot of lien rights against the developer’s parts of the shopping center to secure timely payment of the special service area tax reimbursement

Both contracts include language affirming the developer’s and Home Depot’s intent that the reimbursement and lien rights will “run with the land,” i.e., continue in force: (a) in favor of Home Depot’s successor property owners and (b) against the developer’s successor property owners.

The developer also gets a construction loan. To secure payment under that loan, the developer grants to the construction lender a mortgage against the developer’s parts of the shopping center.

Related to property sale, use, and secured borrowing, the following get recorded, in this order:

  1. Memorandum of purchase contract (specifically mentions reimbursement and lien rights)
  2. Memorandum of OEA (specifically mentions reimbursement and lien rights)
  3. Mortgage from developer to construction lender

And regarding priority relative to other interests in the developer’s property, the OEA says:

  • The priority of liens under the OEA will be set based on the date the OEA memorandum is recorded (i.e., not later, when claim of lien is recorded)
  • Liens recorded under the OEA are subordinate to any first mortgage

Later the developer defaults under the construction loan. The lender sues to foreclose against the developer’s property. And they sue to foreclose and wipe out the reimbursement and lien rights under Home Depot’s purchase contracts and the OEA. The trial court holds that the reimbursement and lien rights are personal, do not run with the land, and the construction lender buys the developer’s part of the shopping center free of the Home Depot’s reimbursement and lien rights. Home Depot appeals.

Covenants Run With the Land

On appeal, the Appellate Court reverses.

First, the justices hold that the reimbursement and lien rights do run with the land. Consequently, they follow from the developer down to the developer’s successors-in-title (here the foreclosing construction lender). The justices explain three elements needed to make these rights run with the land:

  • Intent: The parties to the documents creating the rights must intend for those rights to run with the land. The justices observe that the purchase contract and OEA unequivocally display that intent
  • Touch and Concern: The rights must “touch and concern” the land. Home Depot contends they do. The construction lender contends they don’t. The justices agree with Home Depot: the reimbursement and lien rights do touch and concern the land. The decisive factor: with those rights, the buyer’s part of the shopping center is worth more, and subject to those rights, the developer’s part of the center worth less. If those rights affect value in those ways, they touch and concern the land
  • Privity: There must be “privity” between Home Depot and the construction lender. This means that each must trace their title back to the original parties to the purchase contract and the OEA. The Home Depot is still there and need trace no further. The construction lender acquired their interests from the developer—first a mortgage, then fee title after the foreclosure sale. Observing this, the justices find the privity element satisfied

With each of the three elements satisfied, the justices hold that the reimbursement and lien rights run with then land.

Seniority, Subordination, and Foreclosure

The justices then address whether foreclosing the construction lender’s mortgage wipes out the reimbursement and lien rights, regardless of whether those rights run with the land.

  • They hold that because the memoranda of the purchase contract and the OEA were recorded before the mortgage, those contracts are senior in title and priority to the mortgage. (General rule: the earlier recorded a document, the more senior it is.) And because the mortgage must be senior to the contracts for a foreclose and wipe out the reimbursement and lien rights, this foreclosure doesn’t wipe those rights out
  • The lender counters, contending that though recording sequence initially makes the purchase contract and OEA senior to the mortgage, the subordination language in the OEA demotes the contracts, rendering them junior to the mortgage. The justices rebuff this counter. They remark that although the OEA language subordinates liens imposed under the OEA to the mortgage, that language neither subordinates the OEA at large, nor does it suggest any intent to allow the mortgage to wipe out the OEA

The justices hold that the mortgage foreclosure doesn’t wipe out the reimbursement and lien rights, and consequentially, the construction lender takes title subject to those rights.

Lessons and Observations

  • Contract language matters. Language in the purchase contract and the OEA affirmed that the developer and Home Depot intended the reimbursement and lien rights to run with the land. The justices found that decisive on the first element of their analysis, sparing Home Depot a lot of time, uncertainty, and expense in gathering-up other proof of intent from beyond each contract
  • Recording order matters. The memoranda and the mortgage were recorded within moments of each other. But the sequence was decisive against the construction lender here. Maybe all the parties expected that sequence and its effect on seniority (the subordination language in the OEA suggest maybe they did). But if they didn’t, an out of sequence recording proved expensive, particularly for the lender
  • Contract language matters. If the construction lender expected the subordination language in the OEA to allow the mortgage to foreclose and wipe out Home Depot’s reimbursement and lien rights, they’re probably at the least disappointed. Language subordinating the OEA, and any lien imposed under it might well have worked better in the field
  • Last—and not mentioned in the decision—lender success under the OEA wouldn’t be enough: the purchase contract had no language subordinating its reimbursement and lien rights to the construction mortgage. To win the entire match, more potent language in the OEA would also need to be duplicated in the purchase contract too