Many Washington lenders have assumed that loan advances secured by first-in-time deeds of trust maintain their lien priority over intervening liens, regardless of whether the lenders’ advances are deemed “optional” or “mandatory”. That assumption was based, in large part, on the language of RCW 60.04.226, which provides that “any mortgage or deed of trust shall be prior to all liens, mortgages, deeds of trust, and other encumbrances which have not been recorded prior to the recording of the mortgage or deed of trust to the extent of all sums secured by the mortgage or deed of trust regardless of when the same are disbursed or whether the disbursements are obligatory.” However, academics, title underwriters, and practitioners (particularly those issuing legal opinions) have long questioned whether this statute applied to all real estate secured loans given that it was codified in Washington’s statutes governing construction liens. On June 16, in Commencement Bank v. Epic Solutions, Inc. (In re EM Property Holdings, LLC), the Washington Supreme Court answered the question and ruled that Washington’s lien priority statute does not apply outside of the construction context, and, as a result, an otherwise senior lender’s non-construction advances may lose priority to junior liens if those advances are deemed “optional” rather than “mandatory.”
Commencement Bank involved a priority dispute between a senior deed of trust holder, Epic Solutions, and Commencement Bank as the junior deed of trust holder. Commencement sought to prime Epic’s lien to the extent of advances Epic made after Commencement recorded its junior deed of trust. Epic argued that a future advance clause contained in its deed of trust extended its priority to all future advances and modifications — relying on RCW 60.04.226 to support its position. Commencement argued, in part, that RCW 60.04.226 applies only to construction loans and therefore its second position deed of trust primed Epic’s non-construction future advances. The Court of Appeals upheld Epic’s future advance clause and held that a first position lender may modify its loan and extend additional advances without losing its lien priority if it has a future advance clause in its senior deed of trust. The Court of Appeals also held that RCW 60.04.226 applies to all credit facilities, not just construction loans and liens.
The Supreme Court reversed the Court of Appeals and held that “the language and context of the statute plainly demonstrate it applies only to construction liens. Instead, we are guided by common law, which distinguishes between obligatory and optional future advances. Under that rule, any advances that are optional lose priority to any intervening liens.” As a result, the Supreme Court remanded to the trial court to determine whether Epic, the lender with the first-in-time deed of trust, lost its lien priority under the common law — i.e. whether the advances were optional and, presumably, whether the otherwise senior lender had knowledge of the intervening junior lien.
The Supreme Court’s holding in Commencement Bank requires serious consideration for the administration of real estate secured loans going forward. The following are but a sampling of the post-close scenarios where an otherwise senior lender should consult with counsel and/or its title insurer before making an additional advance:
- Post-default advances which are likely to be deemed “optional” given typical loan document language regarding a lender’s post-default remedies;
- Protective advances to improve the value of collateral rather than to protect and preserve collateral;
- Loan agreement language that provides a lender with unfettered discretion to decline an advance request;
- Uncommitted accordions; and
- Additional extensions of credit intended to be secured pursuant to cross-collateralization clauses.
Under any of the above-referenced scenarios, a lender may lose its lien priority for an advance to a junior lienholder absent an express subordination agreement, particularly if the lender has actual knowledge of such intervening junior lien.
What Should Senior Lenders Do?
The Supreme Court’s deference to the amorphous body of common law surrounding “optional” versus “mandatory” advances will create significant uncertainty in the administration of real estate secured loans. The common law is fact dependent, and the line between optional and mandatory advances is ambiguous. Nonetheless, there are several steps a senior secured real estate lender may take to protect itself, including:
- Strictly enforce prohibitions on junior secured debt;
- Require subordination agreements from junior secured creditors in connection with multiple advance real estate secured loans (and order title updates to identify junior secured creditors who must subordinate);
- Obtain title date down endorsements and consult with its title insurers on the availability of coverage for future advances;
- Include language in loan agreements specifying that advances are mandatory and not optional (at least so long as conditions to the advance are met and/or without undercutting the lender’s right to deny an advance following a default);
- Avoid terminating a commitment if the lender intends to continue making real estate secured advances; and
- When making post-default protective advances, detail the rationale for making the advance to preserve and protect the lender’s collateral.
Ideally, a legislative fix will be enacted that expands the construction lien future advance rule to all real estate secured advances. Until such time, senior lenders should proceed with caution when permitting junior secured debt or when exercising discretion to make a future advance.
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 See, Elmendorf-Anthony Co. v. Dunn, 10 Wn.2d 29, 39-40 (1941).
 See, Nat’l Bank v. Equity Investors, 81 Wn.2d 886, 898-899 (1973) (holding that “the disbursements of funds by the bank under an agreement placing discretionary controls in the lender over the disbursement of the loan funds with an additional reservation that the loan is ‘to be advanced at such times and in such amounts as the Lender shall determine,’…left so wide an area of discretion in the bank as to render the amounts to be advanced and the intervals of their advancing optional rather than compulsory as a matter of law.”)