Construction Financing and Mortgage Priority: What Lenders Need to Know
Construction financing is more complex. While the registration dates of a mortgage and a construction lien are fixed, the priority between them is not. Under Ontario's Construction Act, a mortgage’s priority over a lien depends heavily on the purpose of the mortgage and the timing of their registration.
A lender that fails to structure its mortgage correctly at the outset of registration may find itself competing with unpaid trades over a half-finished project. While the Act provides important protections to lenders who are financing improvements, the purpose of the funds being advanced must be clarified before the very first advance is made.
Here’s what you need to know.
The Purpose of the Loan Determines the Priority Framework
The first question is whether the mortgage has the effect of financing the improvement. If it does, it is commonly referred to as a “building mortgage”, and s. 78(2) of the Act governs.
Lien claimants rank ahead of a building mortgage to the extent of any deficiency in the statutory holdbacks, regardless of whether the mortgage was registered before or after the first lien arose. Registration order alone will not protect a building mortgage from a holdback shortfall.
If the mortgage is not a building mortgage, such as a land acquisition loan or a mortgage securing pre-existing indebtedness unrelated to the improvement, different priority rules will apply. Priority will depend on factors such as when the mortgage was registered, when advances were made, whether the mortgage serves multiple purposes and whether the lender had notice of a preserved or perfected lien at the time of an advance. Accordingly, once a lender receives notice of a preserved or perfected lien, subsequent advances may lose priority to that lien.
Commitment letters and loan documentation should clearly identify the purpose of the financing. In many cases, the lender's priority position is established before the first advance is made, rather than during a later enforcement proceeding.
Holdback Deficiencies Can Affect Mortgage Priority
Under the Act, lien claimants have priority over a building mortgage only to the extent of any deficiency in the statutory holdback. Priority is limited by the holdback shortfall, not the mortgage balance. Because the shortfall, not registration order, drives this exposure, lenders should confirm that the required holdback is being maintained, obtain evidence of holdback retention before releasing advances and account for any potential deficiency when assessing lending risk.
Title Searches Reveal Risks Before Funding Begins
Title diligence is more than a closing formality in construction lending. It is one of the first steps in confirming whether the intended priority position actually exists.
A title search identifies prior registered mortgages, existing construction financing, preserved liens, executions and other encumbrances. Without confirming the state of title and the status of the project at the outset, a lender may later discover that its priority position has already been affected.
If services or materials have already been supplied before the mortgage is registered, the lender may lose the benefit of the prior-mortgage framework under the Act.
Before the first advance, a lender should complete a title search and confirm the physical state of the project – including whether any services or materials have already been supplied – so that its priority position is verified rather than assumed.
Register Your Mortgage Before the First Advance
Securing priority positioning is straightforward: finalize the mortgage documentation, register the mortgage on title and only then release the first advance.
Delaying registration can cost a lender its priority position. A mortgage registered after work has commenced may not receive the benefit of the prior-mortgage framework under the Act, and subsequent advances can lose priority if the lender had notice, or if a lien had been preserved or perfected by the time of the advance.
The Bottom Line
Construction financing requires more than simply registering a mortgage and advancing funds. Loan characterization, statutory holdback compliance, title diligence and registration timing can all affect mortgage priority. By the time enforcement becomes necessary, it may already be too late to correct issues that could have been avoided before the first advance. The good news is that each of these risks can be managed at the outset. A lender that characterizes the loan correctly, verifies holdback compliance, completes title and project diligence, and registers the mortgage before advancing funds puts itself in the strongest priority position from the very first advance.
HOW WE CAN HELP
RAR Litigation advises lenders, developers, contractors and other construction industry participants on construction-related disputes and risk management.
We assist clients with construction liens, priority disputes, mortgage enforcement matters and strategic advice aimed at protecting their interests before disputes arise.
Contact us for strategic advice, risk assessment and litigation representation.