Construction Financing

Before entering into a construction contract the contractor should investigate and be assured that the owner has sufficient funds available to pay all construction costs. That amount should also include allowance for contingencies such as extras, as well as expenses or revenue losses which may result from completion delays or other unforeseen circumstances.

The practice of some contractors of relying only upon their mechanic’ s lien rights in the event of non-payment could be costly. While mechanic’s lien rights usually come ahead of the rights of the construction lender in many states, they may be inferior to the rights of the mortgage on the land itself.

Many owner-contractor disputes appear to surface when the owner does not have sufficient money to pay the contractor. This phenomena appears to occur in greater frequency when prevailing interest rates are high, prompting the owner to defer payments to the contractor, thus saving interest expense.

The wise contractor should require the owner to furnish evidence of adequate financing. He might also request and carefully review construction loan documents in search of any provisions which affect him. Provisions relative to loan funding are particularly important. The contractor should also determine what documentation may be required of him to support funding and what inspections or other involvements he should expect with the construction lender.

Frequently construction loan documents require the lender’s approval of change orders. Although failure to obtain such approval may not prevent the contractor from recovering payment for extras from the owner, it may cut off loan proceeds as a source of such payments

To the extent of the lender’s rights to have its loan paid off, the lender may assert claims against the contractor if his default has actually affected the owner’s ability to pay. This is particularly applicable if the lender had been named as a party or joint obligee of the contractor’s performance bond.

Careful attention should therefore be paid by the general contractor to arrangements for financing of construction, both to assure payment to him and to avoid his possible liability to the lender in the event of his default.

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