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By Dan Harkey
Educator & Private Money Finance Consultant
m: 949 533-8315 | e: [email protected]
1) Introduction:
Real estate is a hard asset and immovable. You can identify, visit, or own it with a government-sanctioned bundle of rights. You may encumber the real estate for a loan by conveying a security interest to a lender. The security interest is attached to the property through a government-controlled public records recording process. A county recorder is appointed or elected to manage the various documents that comprise the community’s records. Public records searches are open to the public.
Actions, agreements, and performances attached to real property in public recordings must comply with laws and regulations and modify or place subject-to conditions on one’s ownership rights.
2) What is a Lien?
A lien is a legal right or claim against real property, a security interest. The lien is given to a creditor (lender) to hold and possess until the loan is paid off.
Property owners/borrowers agree to willingly grant or convey a security interest in their real property by signing a deed of trust or mortgage. As an agreed consideration for the loan, this document must be recorded in a public records office to establish a recorded lien position as a lien attached to a particular real property.
Lenders/creditors are persons or companies who willingly place their capital into loans secured by a security interest in the property. The creditor/lender receives a recorded charging interest and claims against the collateral property.
A lien refers to a monetary (money) claim that will be attached to a property by a recording instrument and becomes an encumbrance on one or more properties.
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3) What is an Encumbrance?
An encumbrance refers to a legal claim or agreement to enforce rights and obligations relating to a property. The claims are against the property by an independent party such as a mutual property association, a court-ordered lien, a municipal notification for substandard conditions or a government agency. The claims restrict the unrestricted use of the property until the deficiencies are satisfied or negotiated into an equitable agreement of future actions. An encumbrance may be lifted, reconveyed, or modified.
There are dozens of events and actions memorialized in written agreements instruments that may be recorded in public records, creating either a lien or an encumbrance on the property. Here are a few:
- a. An originally recorded tract map by the state of jurisdiction for the entire neighborhood.
- b. Utility and other easements, government-mandated conditions such as historical property registries, long-term leases, agreed-on encroachments, air and subsurface rights, height, and view restrictions.
- c. Mutual association by-laws, covenants, conditions and restrictions, entity ownership and partnership agreements, tenancy leases, various public notices such as weed abatement, and notifications of substandard conditions.
- d. Lis pendens, property settlements by adverse parties, divorce decrees, subordination, non-disturbance, and attornment agreements (commonly abbreviated as an “SNDA”), parking easements, reciprocal parking agreements, signage easements, and memorandums of agreement or understanding.
- e. Property taxes, federal or state tax liens, zoning laws, environmental regulations, Etc.
The lending industry sometimes uses the terms lien and encumbrance interchangeably. However, a lien is generally a recorded monetary charge against a property. All liens are encumbrances, but not all encumbrances are liens. They both create claims against the property that impact the ownership rights, processionary interest, and transferability. All three restrict free use until the claim is lifted, reconveyed, or modified.
Some liens and encumbrances may remain on the title of the property. Property ownership may be conveyed to another party by a negotiated purchase contract, “subject to” certain items remaining on the title. A new owner may or may not take steps to have some of the encumbrances removed.
Generally, lenders will not accept irrational or illegal restrictions. Some restrictions cloud the title and may void as a matter of law. I once witnessed a deed that had a condition that the property could not be sold to a person of Asian descent. I also read a deed restricting future property owners from selling or serving alcohol. Fortunately, I did not make a loan or purchase that property.
Some encumbrances negatively affect free use, desirability, and marketability. In some cases, the adverse effects might be significant enough that the title cannot be conveyed legally or transferred to another party.
Dozens of issues may create conflicts, such as disagreements in limited partnership ownership rights, claims of processionary rights, and many other problems. The purchasing party may be unable to convince a title insurer to provide a title policy on the conveyance. In some cases, a court process called a declaratory relief action may be required so that the court can mediate and decide on the validity of the contested claim. In a court process, never expect a rational outcome. Judges are ideologically driven and do not always follow the law.
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4) How does a lien or encumbrance become attached to a property?
The United States has a standardized government records system called the municipal recorder’s office. Whether in a city or county municipality, the recorder’s office maintains public records and documents relating to real estate ownership and other public notices. Their job includes recording and preserving historical records and making them available to the public.
Modern technology has made the recording process and public records management more convenient.
5) What is the purpose of recording documents?
The purpose is to covey constructive notice to the public of recording documents and instruments that affect the chain of title. The objective is to access public records and provide a traceable chain of title documents attached to real properties. Interested parties may trace recorded documents for many years to determine ownership, liens, encumbrances, and whether they were voluntary or involuntary. Recording statutes permit (not require) the recording of instruments that historically affect the chain of title to or possession of the real property.
Suppose a person fails to record an instrument that should have been recorded. Even though a recorded deed is not essential for a valid transfer, an unrecorded deed leaves the property vulnerable to other events and documents that may be recorded. Ignorance could cause another unrelated recorded document to take a senior lien or encumbrance position. The penalty is that the person may have difficulty with any subsequent conveyance action desired to prove ownership or status of the possessory interest.
https://www.boe.ca.gov/proptaxes/pdf/Ownership_DeedRecording.pdf
https://www.investopedia.com/ask/answers/100214/what-real-estate- documents-need-be-recorded.asp
https://en.wikipedia.org/wiki/Recording_(real_estate)
In the past, only paper records existed. Then came what was considered a substantial improvement called a microfiche records database. Microfiche was a flat piece of film that contained microphotographs. These images were photographed and reduced from the original. The materials were made of plastic (acetate) between the 1930s and 1980s, then polyester after the 1960s. The film has a silver-gelatin emulsion coating on it. A single 4 x 6-inch sheet of film may have many separate frames. Copies of documents would be obtained using a scanner and printing device. By today’s standards, this is an obsolete method in our world of instant information.
Public records may contain notices of encumbrance for both voluntary and involuntary rights and claims. Liens and encumbrances create clouds on the title that must be acknowledged and dealt with by the transaction-procuring broker, purchaser or lender. A purchaser or lender may accept the property with questionable conditions, remove it from the title, modify it, or reject it because the risk is too significant.
Each document recorded against the property may contain agreements, considerations, prohibitions, and risks the borrower/lender must consider. A recorded trust deed may have 20-40 pages of legalese that the borrower should review, as should the borrower’s counsel, agent fiduciary, and prudent lender. The document identifies three parties: a lender, a borrower, and a trustee. Documents include a comprehensive property description, an assessor’s parcel number (APN), a granting clause, a legal description, statements, and clauses encompassing all the rights, titles, and interests held by the three parties. Clauses may also include “representations and warranties.” “due-on-sale,” “due-on-further encumbrance,” and “default provisions” by the borrower.
https://www.law.cornell.edu/wex/deed_of_trust
Because of the tremendous complexity, the subject relating to various clauses in loan documents, which will generally create restrictions and prohibitions, should be addressed separately. I encourage interested parties to seek competent counsel advice.
A real estate or lending broker/agent has a fiduciary responsibility to assist the buyer/borrower in understanding all documents relating to a purchase or loan transaction. Below is a good review summary of fiduciary duties.
https://dre.ca.gov/files/pdf/The_Real_Estate_Brokerage_as_Fiduciary.pdf
Sometimes, a property owner may record notices of change of ownership in public records that amend the method of 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 recording a divorce decree or a quitclaim relinquishing one’s ownership interest in the property to another party as part of a negotiated settlement.
As a matter of law, only the trustees of a revocable family trust can hold legal title to real property, not the family trust itself. A revocable family trust is a legal entity that cannot act on behalf of the trust without the trustee. The trust document is an agreement between the key parties of the trust.
6) What is a first, second, and third lien priority position?
Lien priority is proved by the precise date and time when the document is recorded in the recorder’s office and when and where it becomes a matter of public records. When a document is recorded, it is date and time-stamped and affixed with a sequential recording reference number.
Example: If a borrower or their title company recorded three liens simultaneously on a single property, that would create a first, second, and third lien, regardless of the dollar amount of each lien. The first lien, or earliest recorded, is considered a senior lien; the second and third liens are junior liens, with the second lien senior to the third. After the documents are recorded and scanned into the public records, the person who recorded them will receive the originals back in their possession. A title company, lender, or borrower who recorded the documents receives the original date and time-stamped documents with reference numbers to confirm validity and safekeeping.
What ensures the order of the recording to be considered a first, second, or third? How do you know the recorder did not make a mistake and record the documents out of order? You may request and pay for a title insurance policy from an insurance carrier. The title insurance policy guarantees your lien priority position, without which the carrier may be required to pay an incorrect insured claim.
If you were to go to the recorder’s office, stand in line, and have your documents recorded, you should check the recording sequence yourself. But, generally, the recording of documents is done by a title company carrier as part of a sale or loan transaction.
Assume that a property is encumbered with a first lien of $500,000, a second lien of $100,000, and a third lien of $50,000! Assume all were recorded on a subject property properly. If the first lien is paid in full and the trustee records a reconveyance, that procedure will remove the first lien from public records. The second lien would become a first lien, and the third would become a second lien.
A reconveyance is a written form signed by the trustee that is recorded when the lien is paid in full and fully satisfied. The reconveyance shows publicly that the lien has been released and removed from public records. At the point of recording, the security interest is extinguished. Recording the reconveyance is usually done by a title company handling the title work for sale or refinance transactions.
Some states use a satisfaction of mortgage document rather than a reconveyance, but they are essentially the same.
If you were to refinance the same property and replace all three liens into one new single loan, all three liens would be reconveyed by the trustees and removed from public records. A new recording of the single loan with a fresh date stamp and recording number would reflect the new first lien position. The system works well if, for a fee, a title insurer provides an insurance policy that guarantees the lien positions.
7) Voluntary vs. Involuntary liens:
A voluntary lien is a claim that a person or a lender has against the property of another as security for payment of a voluntary debt as agreed to by a borrower. The lien is attached to the property rather than the person. A trust deed or mortgage lien is a voluntary lien. The lien involves legal claims on assets such as real property. An owner may not sell the property or convey title to a third party without acknowledging, dealing with, or extinguishing the lien.
The recorded notice that a lien exists is with the county or municipal recorder’s office. Recording any lien or encumbrance against the private property will cloud the title.
A party may cloud the title for involuntary claims by recording a lien against private property. The owner did not agree to the lien. However, encumbering the property is a method to enforce claims for involuntary debts. This claim includes obligations such as local, state, and federal tax liens, a notice of substandard conditions, contractor claims for mechanics liens, Homeowners association dues, child support payments, and judgments from civil suits.
Liens may be consensual, such as a real estate loan, statutory, such as property taxes, infrastructure bond assessments, or based upon court order. A judgment lien is the most dangerous because a judge can order a recording of a lien on one’s property, whether for rightful reasons or subject to objection.
8) Statutory skipping power in front of other liens:
California law regards lien priority as “first-in-time, first-in-right.” First in time refers to recording with a precise date and time-stamped number. California laws also allow exceptions for some types of liens whereby certain liens are given “skipping power” to the front of the line regardless of recording time. Front of the line means giving priority lien position preference over other recorded liens and encumbrances.
Government regulations permit certain liens to be advanced, so they become the senior priority to other liens. Mechanic’s liens, meant to ensure that tradesmen and contractors are paid promptly, exemplify a priority lien with “skipping power.” The California Constitution protects this right and is further enumerated in the California Civil Code (Section 3110 et seq.)
However, there are limits on the “skipping power” of mechanics liens. These relate to technical requirements, such as when the construction began and the claimant’s process to enforce that lien. Even when the mechanic’s lien appears to have been “wiped out or extinguished” 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 consult counsel knowledgeable about construction and mechanics lien law.
Other exceptions relating to “skipping power” may include property taxes, special tax assessment districts, and, in some states, homeowners or mutual property associations.
A written lease agreement has a “first-in-time, first-in-right” priority. Lessees (tenants) who have written lease agreements recorded at the county recorder’s office that are date and time-stamped before recording the new trust deed will have a right to enforce the terms of the lease agreement and right of continued occupancy. The lessee’s rights will run with the property until the lease terms (rights) expire or are modified in writing by mutual agreement. Below is an instructive example.
https://law.justia.com/cases/california/court-of-appeal/4th/65/1469.html
9) Lien priority may be modified through written agreements:
There are many reasons to create written agreements that modify the lien priority by mutual understanding. One method is called a subordination agreement. This agreement makes the subject lien junior to another lien even though it was recorded earlier with an earlier date stamp.
A real estate lender may condition the approval of a loan upon a written modification of the statutory priority. A written agreement between the borrower, the tenant, and the lender may be required for approval and loan closing. A straight subordination agreement or a subordination, non-disturbance, and attornment agreement (SNDA) may be advised. Both agreements, when recorded, are encumbrances on the property.
Sometimes, it is in the lender’s best interest to terminate the tenancy in case of borrower default and completion of a foreclosure procedure. In this case, a straight subordination signed by the tenant would be appropriate. Any action causing a change in the chain of title may cause the lessee’s priority to be lost. If the lessee’s priority is lost, he could be notified to vacate and be kicked out of the property.
In some commercial transactions, the lender may wish to preserve the tenancy of credit tenants to preserve the property’s cash flow, stabilized occupancy, and capitalized value. A subordination, non-disturbance, and attornment agreement “SNDA” may be the appropriate document to record. SNDAs are agreements between a lessee (tenant), the lessor (landlord), and the lender. The SNDA defines certain rights and responsibilities of the parties. The SNDA will protect the lessee or tenant from being evicted if the owner (landlord) stops paying the loan payments to the lender(s), resulting in a completed foreclosure. Other parties may be affected, such as a purchaser of the property.
https://www.jdsupra.com/legalnews/snda-what-is-it-and-why-is-it- important-97709/
10) Modifying the rights and responsibilities of senior and junior lien parties:
An inter-creditor agreement may be advised. This agreement does not modify the lien positions between junior and senior lender creditors.
An inter-creditor is a written agreement between two creditors intended to memorialize how their competing security interests will be handled when each possesses liens (a claim or money charging interest) in a joint borrower and secured property. This agreement is used between two (or more) senior/junior lenders to establish rights and responsibilities between each lender. The agreement typically provides that one lender’s lien is senior to the other regardless of when and in which order the liens were recorded.
Sometimes, the actual agreement is a “subordination and inter-creditor agreement.” This document allows two different lenders to “split up” the collateral so that both will be secured in an equal first or junior lien position for their collateral, subject to the terms and conditions of the agreement.
The inter-creditor agreements, when recorded, are an encumbrance against the property.
If you find value in this article for you and your associates, please forward it to others who may appreciate the education. I am sure that the reader realizes the importance of competent legal counsel.
Thank you,
Dan Harkey
Dan Harkey
Dan Harkey is a contributing author to Weekly Real Estate News and is a Business & Financial Consultant. He can be contacted at 949-533-8315 or [email protected].
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