Don’t Get in Front of Your Bank – A Pitfall for Construction Financing

Don’t Get in Front of Your Bank – A Pitfall for Construction Financing

By Christopher W. Peer, Esq.

Most contractors and construction professionals understand that it is critical to obtain financing before beginning the project. Why is this? Well, this question has come in recently and the answer is you might not get the financing you are expecting!

Professionals and contractors alike know that sizable construction jobs start with a recorded Notice of Commencement, which puts the world on notice that construction is taking place and contractors will be on site. The Notice of Commencement has two other important purposes:

First, the Notice of Commencement tells the world that the contractors on site are doing work and expect to be paid (and have statutory Mechanics’ Lien rights). Second, and possibly more important, is that the Notice of Commencement is a recorded document establishing priority of the project in the real property that is the subject of the project.

This second item is where lenders get cranky if the project has begun before financing has closed and the lender has recorded its customary mortgage (and likely other protections like Assignments of Rents and Leases). If the project starts ahead of financing and the Notice of Commencement is properly filed, there is a strong argument that contractors working on the job before the Mortgage is filed can come first in time for payment (even downstream in some instances) from the property itself. This is never a problem in a successful project but a huge problem in a project with cost overruns or that is bid extremely thin. This ability to prime the lender will fairly concern and often scare most lenders because they are providing the funds and expect to be repaid first in all events, and especially in the event of a distressed project.

This concern of risk of re-payment will cause lenders to “run for the hills” when faced with this situation, and disappoint even the strongest of contractor relationships and subterfuge an otherwise promising project. So, keep this in mind for the next project, and be certain that all interested parties take action in the right order, preserving the rights (and cash) from the funding sources.