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
- 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
- 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.