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Avoid Lender-Contractor Conflicts in the Construction Process By John R. Blake, Jr., Esq.

Friday, December 12, 2003 - By: John R. Blake, Jr.

By John R. Blake, Jr., Esq.

Financing a construction project presents a myriad of issues for the owner. In fact, it requires the owner to negotiate separate contracts with two parties that have differing, and possibly conflicting, objectives. The owner's task is to negotiate the terms of both agreements so that the owner is not at odds with either or both the lender and the contractor during the construction process. Ultimately, the owner wants a project proceeds in an efficient manner.

Identifying areas of potential conflict between the contractor and the lender, and addressing those areas during the negotiation of the construction contract and the loan documents, is the key to avoiding possible disruption or delay. The construction contract and the loan documents are often negotiated and finalized separately from each other (in some cases, the lender will review and approve the construction contract as part of the underwriting process). However, having a list of the relevant issues when dealing with both sides is helpful in keeping the negotiating points straight and keeping both agreements on track.

Below are some of the steps an owner can take to avoid potential conflict:

  • Ask the lender for its underwriting requirements. Attention to the Lender's underwriting requirements early on in the process can help the owner to line-up reports needed from third-parties involved in the project. If the lender requires an ALTA survey, an engineer's certification and/or a zoning opinion at the time of the closing, the owner can put those items out to bid early with engineers and surveyors. By doing so, the owner can avoid last-minute scrambling to meet the lender's requirements for an imminent closing (when the ability to shop price is greatly diminished).
  • Review the loan documents as soon as possible. The owner should obtain the lender's term sheet and draft loan documents, or at least samples of the lender's form documents, as early as possible in the process. The loan documents contain the provisions which govern the process for requisitions of loan advances, deadlines for requests, inspections, lien waivers, and holdbacks. The potential for a gap in the expectations of the contractor and the lender can be averted if the lender's requirements are known in advance.
  • To the extent possible, conflicting terms in the loan documents and the construction contract should be reconciled. For example, if the loan documents specify that an interruption in construction for a specific period is a default, the construction contract should not allow the contractor to have a longer period of interruption before he is in default of that agreement. Similarly, provisions as to dates for completion of construction, and excuses for delays in completion, should also be checked.
  • Obtain the contractor's agreement to lender's terms which directly involve the contractor. In some cases, the lender requires a collateral assignment of the owner's interest in the construction contract. Such an assignment may limit the contractor's ability to accept change orders over a particular dollar value, which reduces the lender's exposure in the event of a default where the lender becomes the owner and must complete the project. Typically, a contractor will resist any limits placed on its authority to keep the project moving according to its usual practices. The owner can increase its chances of forging a compromise between the contractor and the lender if the issue is raised early in the negotiations with those parties.

While no one can foresee every conflict or complication that may arise during the construction and financing process, minimizing the number of possible conflicts during the negotiation process can tip the scales in the owner's favor for a smooth and successful project.