Lien priority: Overview, definition, and example
What is lien priority?
Lien priority refers to the order in which creditors or parties with liens on a property are paid in the event of a sale, foreclosure, or liquidation of that property. When multiple liens exist on a property, lien priority determines which creditor has the first claim to the proceeds from the sale of the property. The priority of liens is usually determined by the type of lien and the date it was recorded or attached.
For example, a mortgage lien may take priority over a tax lien, meaning that the mortgage holder will be paid first from the sale of the property.
Why is lien priority important?
Lien priority is important because it ensures fairness and clarity in the distribution of proceeds from the sale of an asset. It helps protect the rights of creditors by establishing the order in which claims will be satisfied. Lien priority is particularly significant in foreclosure situations, where the proceeds from the sale of a property may not be enough to fully satisfy all outstanding liens.
For property owners, understanding lien priority is crucial to understanding the potential risks associated with taking on additional debt or using property as collateral. For creditors, lien priority determines the likelihood of recovering their funds in the event of default or liquidation.
Understanding lien priority through an example
Imagine a homeowner has three different liens on their home:
- A first mortgage lien for $200,000
- A second mortgage lien for $50,000
- A tax lien for $10,000
If the home is sold for $220,000 due to foreclosure, the first mortgage lender will be paid first, and they will receive the full $200,000. The remaining $20,000 will then go toward the second mortgage lien. Since the tax lien is in third position, it would only receive payment if there are remaining funds after the first and second liens have been paid. If there are no remaining funds, the tax lien holder would not be paid.
Example of a lien priority clause
Here’s how a lien priority clause might appear in a contract:
"In the event of a sale or foreclosure of the Property, the priority of liens shall be as follows: (i) the first mortgage lien shall take priority over all other liens, (ii) the second mortgage lien shall be paid after the first mortgage lien, and (iii) any junior liens, including the tax lien, shall be paid after all senior liens have been satisfied. The Borrower agrees that this order of priority shall govern in the event of default."
Conclusion
Lien priority determines the order in which creditors are paid from the proceeds of a property sale, making it a crucial factor in asset liquidation and debt recovery. Understanding lien priority helps both property owners and creditors manage risks and expectations in situations involving multiple claims on the same property.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.