The After-Acquired Property Clause: Potential Dangers and What to Do About Them
Thomas J. Barnes, Esquire
Often real estate investors will ask their lender for a loan large enough to finance both the purchase of a property they intend to buy now, and also to finance the purchase of one or more properties in the future. The loan might take the form of a line of credit. The mortgage states that property X is covered, and the mortgage is filed in the county where property X is located. The mortgage might also state that it covers any properties the borrower acquires in the future with the loan proceeds (the “after-acquired property clause”). There is no trouble at this point. The mortgage is completely effective against the collateral and there is no barrier to foreclosure if the loan becomes troubled.
It is important to be aware of the situation when the borrower buys another property using the loan proceeds, and no one files any documentation in the land records, either in the original county where property X is located or where new property is located. The lender is still on solid ground, because the original mortgage is effective against the borrower and the new property (property Y). This is so even if property Y is located in a different county, or even in a different state. If the loan becomes troubled, the lender can take back both property X and property Y.
An issue may occur when the borrower conveys an interest in property Y to someone else. If the borrower sells it outright, the lender will lose any mortgage interest it had in property Y. The new purchaser would take title to property Y free and clear of the lender’s original mortgage with the after-acquired property clause, because he/she most likely did so without ever knowing it existed. That new purchaser is innocent in the eyes of the law and the original mortgage is null and void as to him/her. Similarly, if the borrower does not sell property Y, but does something such as borrow money from someone else without telling the original lender, and uses it as collateral, the original mortgage becomes junior to the new lien.
In Pennsylvania, a mortgage that goes unrecorded is effective between the parties, but is null and void as to someone who gives value for an interest in land and does so without actual or constructive notice of the mortgage. With a recording statute like Pennsylvania’s, the lender/mortgagee’s lien in after-acquired property (Y, for example) will be subordinate to the interest of someone who pays value and lacks notice of it. In our scenario, an outright sale of property Y would make the mortgage on property X meaningless. It would be treated as unrecorded. If, instead of selling it, the borrower mortgaged property Y to another lender, the original lender’s lien would become junior to the interests of the new mortgagee.
The idea is to protect the person acquiring the land, who probably would not have discovered it until after a reasonably diligent search of the records. The mortgage is not in the “chain of title”. The original mortgage will only refer to property X. Forcing a title searcher to check every entry in the grantor-grantee index is considered to be too much to require. The title searcher for the innocent purchaser of property Y would have to check all the land records in every surrounding county to look for the lender’s original mortgage. It would be impractical and unfair to require the title searcher checking the chain of title for property Y to research every conveyance ever made to the borrower. If the borrower is an active land speculator with holdings in several states, the job would be astronomically expensive, time-consuming, and nearly impossible.
To avoid this result, the lender must record a notice in the county where property Y is located that specifically identifies property Y, refers to the mortgage containing the after-acquired property provision, and is in a form that provides record notice under local law. Of course, this must be done before the new purchaser records the deed. Recording such a notice has the effect of making the after-acquired property clause part of the chain of title. Interests in the property that arise after recording will be junior to the lien of the after-acquired property clause.
Under this rule, an after-acquired property clause does not add much value and holds real potential for trouble unless the lender keeps a close eye on associated transactions. At a minimum, that means setting up systems and procedures designed to make sure loan proceeds are released to the borrower only if the lender gets a description of the new property. The lender should also make sure that if and when property is acquired, the correct form of notice is filed in the land records in the county in which the after-acquired property is located so that anyone researching the title will be aware of the lender’s original lien.
Thomas J. Barnes is a lawyer who concentrates his practice in commercial real estate finance, commercial transactions, and general corporate and business law. Mr. Barnes is a partner of the Jenkintown, Pennsylvania firm of Egbert & Barnes, P.C.
