On July 9, 2014, Pennsylvania Governor Tom Corbett signed into law Act 2014-117 (S.B. 145), amending Section 1508 of the Mechanics' Lien Law (49 Pa. Cons. Stat. § 1508(c)) to overrule the restrictions placed on granting priority to open-end mortgages over mechanics' liens by the Superior Court of Pennsylvania in Commerce Bank/Harrisburg, N.A. v. Kessler (46 A.3d 724 (Pa. Super. 2012)). This act went into effect on September 8, 2014.

Pennsylvania's Open-End Mortgage Act allows mortgages to secure future advances and retain lien priority as of the mortgage recording date if the mortgage:

(42 Pa. Cons. Stat. § 8143.)

Open-end mortgages in Pennsylvania were granted superiority over mechanics' liens by Section 1508 of the Mechanics' Lien Law, enacted in 2007, which stated that mechanics' liens would be subordinate to open-end mortgages if the loan proceeds were used to pay "all or part of the cost of completing erection, construction, alteration, or repair of the mortgaged premises." Title companies and lenders widely interpreted this statute to give open-end construction mortgages a super priority over mechanics' liens.

In Kessler, the superior court held that an open-end mortgage only had priority over a mechanic's lien if all of the mortgage proceeds were used to pay the hard costs of completing the erection, construction, alteration or repair of the mortgaged premises. This was a significant departure from the prior application of the law, where even if any portion of the proceeds were used toward the soft costs of construction, the open-end mortgage had priority.

This development caused great concern in the Pennsylvania construction lending and title insurance market, where open-end mortgages are frequently used to secure many project costs in addition to the direct construction costs, including the acquisition of the property itself. As a result of Kessler, open-end mortgages filed after work commenced no longer had priority over mechanics' liens if any amount of the mortgage proceeds were used for costs other than erection, construction, alteration or repair of the mortgaged property.

As a result, lenders attempted to structure loans so that they had title insurance coverage against mechanics' liens when visible construction was evident before the mortgage recording date, often creating separate loans for hard and soft construction costs or requiring developers to use their own equity to fund the soft cost portion of the transaction.

In response to Kessler, the Pennsylvania legislature enacted Act 117 of 2014, overruling the court. Act 117 amends Section 1508(c) to grant priority to open-end mortgages over mechanics' liens where at least 60% of the loan proceeds are used to pay or are intended to pay all or part of the costs of construction, even when the commencement of work was visible before the mortgage recording date.

The statute also expanded the definition of "costs of construction" to expressly encompass the "soft cost" standard in place before Kessler (49 Pa. Cons. Stat. § 1201(15)). These include but are not limited to common closing and construction-related costs, such as:

This Act went into effect on September 8, 2014 for mechanics' liens perfected on or after that date, even if work was performed before the effective date. Lending institutions and title companies should now be able to determine if a proposed loan will attain super-priority status by reviewing the construction budget, which should provide for increased speed and flexibility of originations of open-end mortgages for construction loans. Similarly, commercial construction borrowers who seek an open-end mortgage to secure a construction loan can structure their budgets to make themselves desirable to lending underwriters.