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Priority Risks In Real Estate Secured Future Advances
BY: John Burrus, Esq.

Real estate secured credit products which involve disbursements to be made in the future - so-called "future advances" - are common. Examples include construction loans and revolving credit lines, including the ordinary home equity credit line. What are the rules governing the priority of these sorts of advances in relation to liens or other interests arising after the deed of trust is recorded but before a particular advance is made?

In Kimmel v. Batty, 451 P.2d 751 (Colo. 1969), the only Colorado case which has considered the issue, the Colorado Supreme Court adopted the so-called "optional/obligatory advance" doctrine which is followed in most other states. If the lender is contractually obligated to make the advance, the funds advanced will have priority over intervening interests. If the lender could have lawfully declined to make the advance, then interests which attached before the advance was made will have priority over the newly advanced funds*. Most states also require that, for the intervening interest to obtain priority over these advances, the lender must have received prior notice of the interest. Some states require actual notice, but most accept recording of the interest as sufficient whether or not the lender actually knows of the interest or of its having been recorded. No Colorado case has addressed the issue of whether notice is required or whether recording constitutes sufficient notice.

Whether a particular advance is to be considered optional or obligatory is an issue which has often been addressed in contradictory and confusing ways by different courts. Construction loans and real estate secured credit lines will commonly include provisions which require that certain conditions be met before the lender is obligated to fund draws or make other advances. For example, a construction loan agreement will usually require that loan proceeds be used for stated purposes and that construction be performed in accordance with specified standards. A credit line agreement will generally require that the borrower's financial condition remain unimpaired. Some courts have held that a lender which makes an advance when it could have lawfully declined to do so because required conditions have not been satisfied has made an "optional" advance which is junior in priority to intervening interests. Other courts have reached opposite results under similar circumstances. No Colorado case has addressed the issue.

Given the current state of uncertainty in Colorado concerning the priority which will be given to real estate-secured future advances, a lender should be aware of the potential risks involved in construction loans, home equity credit lines and similar products. When practical, this risk can be reduced by updating title work before making any advance which might be deemed optional in character. This, of course, is often not practical or even possible with respect to credit lines, such as home equity lines, which are automatically accessed by check or debit card. The Colorado lender has no practical way to protect itself in these latter situations and should consider this added risk when agreeing to extend this type of credit.

*The situation is different for future advances secured by personal property. The "first to file or perfect" rule of Article 9 generally gives priority to all future advances, optional or obligatory, over intervening interests.

Contact John E. Burrus at jeb@bsblaywers.com

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