Client Alerts | Shefsky & Froelich - Lawyers with Real Imagination

Client Alert: Mechanic Lien Priority

February 22, 2013

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In February 2011 the Illinois Supreme Court issued its opinion in LaSalle Bank, N.A. v. Cypress Creek I, LP, announcing a new interpretation of the rules governing distribution of proceeds between a mortgage lender and mechanic lien claimants in a situation where 1) the mortgage was recorded before the construction contract was made; 2) the borrower defaults; 3) the lender elects to continue funding improvements from the construction loan; and 4) proceeds generated by foreclosure sale are insufficient to satisfy all claims.

Before Cypress Creek, the law was commonly understood as granting the mortgage lender a priority interest in that portion of the sale proceeds attributable to the value of the land before the construction contract was made, and granting the lien claimants priority in that portion of the proceeds attributable to the improvements they constructed pursuant to the contract. The court in Cypress Creek departed from the traditional analysis, holding that where a mortgage lender has funded a construction loan and paid for some of the improvements with that funding, the lender will: 1) continue to have priority in that portion of the sale proceeds attributable to the value of the land before improvements, and 2) in addition, will share priority with lien claimants in that portion of the proceeds attributable to improvements, proportionately to the value of the improvements it funded.

The Cypress Creek opinion effectively increased the lender’s share of the proceeds realized from a foreclosure sale, and decreased the share available to the lien claimants. Applied prospectively, Cypress Creek will operate to benefit construction lenders and to the detriment of unpaid mechanic lien claimants. As a result, the construction industry lobbied the Illinois General Assembly to enact legislation to overturn the Cypress Creek opinion while the banking industry lobbied to retain the Cypress Creek holding. The construction industry lobby prevailed and House Bill 3636 has been passed by the both the House and Senate, and was signed into law by Governor Quinn on February 11, 2013. It is now in effect.

HB 3636 will implement the following rules for determining priority of interests in proceeds of sale where the mortgage was recorded before the construction contract was made, and foreclosure sale proceeds are not sufficient to satisfy all claims:

The mortgage lender with a previously recorded mortgage will take priority in that portion of the proceeds of sale attributable to the value of the land at the time that later construction contract was entered.
Unpaid mechanic lien creditors will share priority in the portion of the proceeds attributable to the value of all subsequent improvements made to the property, pro-rata.
The lender will not share in proceeds attributable to improvements made pursuant to the construction contract, even if the lender funds subsequent improvements from its construction loan.

Some observers have made dire warnings that passage of HB 3636 will discourage construction lending, since lenders will no longer enjoy the advantages announced in Cypress Creek.

This need not be the case. Construction lenders can structure loan documents and payout methods to preserve parity of interest with unpaid mechanic lien claimants, leading to a lender’s greater probability of enhanced recovery in distressed development projects.

To obtain further information, you may feel free to contact either Edward J. Halper (312-836-4188, Ehalper@shefskylaw.com) or Elizabeth J. Boddy (312-836-4084, Eboddy@shefskylaw.com).

Circular 230 Notice. To ensure compliance with requirements imposed by regulations governing practice before the Internal Revenue Service, unless expressly stated otherwise, any advice contained in this communication concerning tax issues cannot be used, and is not intended to be used, for (i) the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or (ii) the promotion, marketing or recommendation of any transaction or matter discussed in this communication.

Client Alert: New Tax Provisions Under the American Taxpayer Relief Act of 2012

January 8, 2013

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Congress passed the American Taxpayer Relief Act of 2012 on New Year’s Day, enacting important changes to the Internal Revenue Code, including income tax and estate tax rules. This legislation has been signed into law by the President and resolves the tax issues which were discussed as part of the so-called “fiscal cliff” negotiations. In addition, certain changes also are effective beginning in 2013 that were enacted as part of the Patient Protection and Affordable Care Act (Obamacare).

Important changes to the tax laws in 2013 include:

Income Tax Rates. Income tax rates are made permanent for most individual taxpayers. The top marginal income tax rate, however, reverts to 39.6% (from 35%) for single individuals with income over $400,000 and joint filers with income over $450,000 (and a threshold of $425,000 for heads of households). The thresholds for tax brackets are indexed for inflation.

EXAMPLE: A couple with $600,000 of taxable income (income after permitted deductions) will be subject to the new 39.6% rate only on $150,000 of income ($600,000 - $450,000). The amount of tax owed in 2013 would be $6,900 more than under the 2012 tax rates ($150,000 x (39.6% - 35%)).

Capital Gains. Capital gain rates are made permanent for most individual taxpayers. However, the top marginal capital gain rate reverts to 20% (from 15%) for the same higher thresholds as for ordinary income.

Dividends. Dividend income remains taxable at the same rate as capital gains (including the increase for top bracket taxpayers to 20%). Dividends were scheduled in 2013 to revert to being taxable as ordinary income, but this legislation averts that increase.

Itemized Deductions. The limitation is reinstated on itemized deductions, which reduces itemized deductions by 3% of the amount by which a taxpayer’s adjusted gross income exceeds a threshold (subject to exclusions for certain deductions) up to a maximum reduction of 80%. The threshold is $250,000 for single individuals and $300,000 for joint filers ($275,000 for heads of household). These thresholds also are indexed for inflation.

EXAMPLE: If a couple filing jointly has $400,000 in adjusted gross income in 2013 and their itemized deductions are $80,000 (and assuming no itemized deduction are in the list of excluded deductions), the couple will have their itemized deductions reduced by $3,000, to $77,000 (($400,000 - $300,000) x 3% = $3,000). The couple will pay an additional $1,050 in income tax (35% of $3,000).

Personal Exemption. The phase-out of the personal exemption is also reinstated, which reduces a taxpayer’s personal exemption by 2% for each $2,500, or portion thereof, by which the taxpayer’s adjusted gross income exceeds the same thresholds applicable for the limitation on itemized deductions.

EXAMPLE: If a single individual has $275,000 in adjusted gross income in 2013, the individual’s personal exemption will be reduced by 20% (((275-000 – 250,000) / 2,500) x 2). Thus, the personal exemption is reduced from $3,900 to $3,120.

AMT. Permanent Alternative Minimum Tax relief increases the exemption amount to $50,600 for single individuals and $78,750 for joint filers, indexed to inflation.

Investment Income Surtax and Medicare Tax. Under Obamacare, certain non-corporate taxpayers with incomes in excess of $200,000 for non-joint filers and $250,000 for joint filers may be subject to a 3.8% Medicare surtax on certain investment income. Wages in excess of these thresholds also generally are subject to an additional Medicare tax of 0.9%.

Other Individual Income Tax Benefits. Numerous individual income tax benefits have been extended through 2013, including above-the-line deduction for teacher expenses, relief from cancellation of debt income for principal residences, deduction for mortgage insurance premiums as interest, election to deduct state and local sales taxes instead of income taxes, above-the-line deduction for qualified education expenses and tax-free distributions up to $100,000 per year from IRA accounts to public charities.

Other Business Income Tax Benefits. Several business income tax benefits have been extended through 2013, including the research credit, the new markets tax credit, the railroad track maintenance credit, the mine rescue team training credit, the work opportunity credit, the $500,000 expense threshold under Section 179 (allowing immediate expensing of certain capital asset purchases by small businesses), the 100% capital gain exclusion for Section 1202 stock, the 50% bonus depreciation and empowerment zone incentives.

Additional Payroll Tax. The new law does not extend the 2% payroll tax holiday. This results in a reversion of the employee portion of Social Security payroll taxes from 4.2% back to 6.2%. The employer portion remains at 6.2%. The wage base cap for Social Security Taxes also rose to $113,700 in 2013 (up from $110,100 in 2012) under the normal wage adjustment formula.

The combination of these rate and wage base cap increases results in the maximum employee contribution to Social Security withholding increasing by $2,425 ($7,049-$4,624). Medicare payroll taxes remains at 1.45% for the employer portion and 1.45% for the employee portion on all wages (not subject to the wage base cap), plus the new additional 0.9% Medicare tax described above.

Estate and Gift Tax Exemption. The estate and gift tax emption level remains at $5 million, indexed for inflation (rather than reverting to $1 million). Due to the inflation adjustment, in 2013 the exemption level likely will be close to $5.25 million per person ($10.5 million per married couple).

NOTE: Due to portability (as discussed below), this means that married couples with combined estates of about $10,500,000 will be federal estate tax free. Most married persons now will be able to plan their estates without significant transfer tax considerations.

Estate and Gift Tax Rates. Estate and gift tax rates now increase to a maximum rate of 40% from 35%. Prior to this recent legislation, the rate was scheduled to return to a maximum rate of 55% as of January 1, 2013.

Spousal Estate Tax Portability. Portability of any unused gift and estate tax exclusion between spouses has been made permanent. In other words, if the total exemption level is $10.5 million for a married couple, the exemption can be used between them in any combination.

EXAMPLE: If a wife makes lifetime or testamentary gifts of $2.5 million (excluding transfers to her husband), then after her death her husband can use his wife’s unused $2.75 million exemption in addition to his own exemption of $5.25 million (as further adjusted for inflation) for his lifetime or testamentary gifts.

Other Estate Tax Changes. The federal deduction for State estate taxes, which was scheduled to expire, was retained. Several technical changes also were made to the generation-skipping transfer tax, mostly relating to valuation and the allocation of the tax exclusion.

We would be pleased to work with you to identify how these changes in tax law affect you or your business. Please contact Rick Aderman at 312-836-4104, Michael Friedberg at 312-840-4396 or the attorney at our firm with whom you usually work if you wish to discuss these issues further.

Circular 230 Notice. To ensure compliance with requirements imposed by regulations governing practice before the Internal Revenue Service, unless expressly stated otherwise, any advice contained in this communication concerning tax issues cannot be used, and is not intended to be used, for (i) the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or (ii) the promotion, marketing or recommendation of any transaction or matter discussed in this communication.

Municipal Client Alert: Property Seizures Under Drug Asset Forfeiture Procedure Act

February 22, 2012

Client Alert: Traps for the Unwary, Additional Insureds Under Commercial General Liability Insurance-Coverage Gap or Illusory Insurance?

July 14, 2011

Download full Client Alert here.

It is common when services are to be provided that the recipient of the services requires that it be named as an additional insured on the provider’s commercial general liability policy (CGL) as additional protection if the service provider breaches its obligations. Those obligations may include performing the work in a safe and sound manner, protecting the service recipient from negligence claims and the like. On March 29, 2011, the U.S. District Court for the Northern District of Illinois ruled that an additional insured was not covered by its service provider’s CGL policy for injuries and damages incurred by the provider’s employee. (Archer Daniels Midland v. Burlington Insurance Company, 10-CV-1533.)

Independent Building Maintenance Company (“IBM Co.”) provided window washing services to Archer Daniels Midland, and ADM was named as an additional insured on IBM Co.’s CGL policy. IBM Co.’s employee was injured on the job and sued ADM for alleged negligence and premises liability. ADM asked IBM Co.’s CGL insurer to defend and cover the claim, but the CGL insurer for IBM Co. refused. This is not an academic issue; ADM has asserted $350,000 in damages in attorney fees and settlement costs with IBM Co.’s employee.

The insurance company asserted two defenses. First, that the policy included a typical employer’s liability exclusion, which bars coverage for personal injury claims by an “employee of the insured.” The District Court judge construed the policy provisions and, citing an Illinois Supreme Court decision, held that a severability clause in the insurance policy provided each insured, IBM Co. and ADM, with separate coverage, so that a claim of injury by IBM Co.’s employee against ADM would be covered under the policy. Essentially, a severability clause is intended to treat each entity covered under a policy as if each were separately insured. And the clause is designed to preclude “over-coverage”—an injured employee has a worker’s compensation claim but not a general liability claim against the employer.

Secondly, the insurance company also raised a defense based on a cross-liability exclusionary endorsement. That endorsement bars coverage for any claim brought by any insured (or its employee) against “any insured” (or its employee). The District Court judge specifically stated that the cross-liability exclusion referenced “any insured,” as opposed to the employee exclusionary clause that bars coverage for claims to employees of “the insured.” So, the judge held that there was no coverage for ADM because of the cross-liability exclusionary endorsement. The District Court judge further noted that there was no public policy that would operate to limit the cross-liability exclusion.

ADM also argued that naming ADM as an additional insured, but denying coverage to a claim by IBM Co.’s employee rendered the insurance coverage illusory and that the exclusions were accordingly void. But the District Court judge held that there could be other perils still covering ADM under the policy, not involving an injury to an IBM Co. employee, and rejected ADM’s contention of illusory coverage.

ADM has appealed this ruling to the Seventh Circuit Court of Appeals, but an appellate ruling will probably not be issued until 2012.

WHAT SHOULD AN ADDITIONAL INSURED DO TO AVOID THE COVERAGE GAP?

• Do not rely merely on a certificate of insurance. That certificate must signed by the insurance company or its agent—not the insured’s insurance broker. But even if it is properly signed, it merely evidences that there is insurance subject to the policy’s conditional coverages and exclusions.

• Obtain a copy of the policy and carefully review with your counsel the policy coverage, exclusions and other terms. But this may merely alert you to the issues and an understanding of the interrelationships of clauses and endorsements in a CGL policy.

• Require under the contract that the provider deliver a certificate of CGL insurance naming the additional insured but waiving/deleting/modifying the applicability of the cross-liability exclusion. (This assumes that the CGL insurer will consent to such a waiver/ deletion.) This “heavy lifting” should probably be handled by the service provider’s insurance broker.

• If there are coverage gaps that the insurer will not modify, carefully consider the strength of the contractual indemnity obligations of the service provider and the economic viability of the service provider. Without CGL insurance coverage, does the service provider have the independent financial strength to pay its contractual indemnity obligations absent insurance coverage?

There are no simple solutions; hopefully the Court of Appeals will reverse, thereby giving additional insureds the protections they anticipate and avoiding a coverage gap.

We would be pleased to answer any questions you may have.

Edward J. Halper
312.836.4188
ehalper@shefskylaw.com

Jack Hagerty
312.836.4055
jhagerty@shefskylaw.com

To ensure compliance with requirements imposed by regulations governing practice before the Internal Revenue Service, unless expressly stated otherwise, any advice contained in this communication concerning tax issues cannot be used, and is not intended to be used, for (i) the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or (ii) the promotion, marketing or recommendation of any transaction or matter discussed in this communication.

Client Alert: Foreclosure Sale of Distressed Real Estate Developments Changes in Mortgage Lender – Mechanic Lien Priority Rules

March 31, 2011

Download a PDF of this Client Alert. On February 25, 2011, the Illinois Supreme Court issued its opinion in LaSalle Bank, N.A. v. Cypress Creek 1, LP, announcing a new rule for the distribution of … [ Read More ]

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February 09, 2011

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May 14, 2009

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March 24, 2009

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