Recent Trends in Construction Lending: The

Lender’s Perspective

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Harriet B. AlexsonBohm Wildish, LLP

695 Town Center Drive Suite 700Costa Mesa, CA 92626

Ph: 714-384-6578 Fax: 714-384-6501halexson@bohmwildish.com

www.alexsonlaw.comTwitter- @bethalexson

https://www.linkedin.com/pub/harriet-alexson/22/744/667©2014. All Rights Reserved.

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Construction Lender vs. Permanent Lender

• Permanent Lender- usually a state or financial institution primarily interested in a long term loan.

• There could be a commitment in place for the permanent or take- out financing at the time of the construction loan.

• Construction Lender- usually a commercial bank primarily interested in making short term, floating rate loans

• Construction lending is labor intensive and construction loan departments are usually well-staffed with loan administrators with expertise in the disbursement process.

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DisbursementsConstruction Lender is the disburser of funds. The project should be

constructed as designed in the plans and specs. Those contributing services and materials are being paid as agreed in the various,

developer, contractor, and/or sub-contractor agreement, as applicable. Borrower typically provides bank with a request for disbursement.

ContractorIts Draw Inspector

Monitors ConstructionArchitect/ Engineer

Mechanics Lien Claimants

Fixture financers

BorrowerSubcontractors

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Underwriting Issues

1. Discussion of loan pricing 2. Collateral Requirements

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Overview Liability for Construction Defects

• In general, the Lender is liable for defects only in limited circumstances:1. If Lender and Developer are joint venturers2. If a construction lender continues to disburse

funds after receiving notice of defects3. If Lender takes over construction upon a default

and completes the project

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The Construction Loan Agreement

Key issues when drafting the Construction Loan Agreement. Discussion of the disbursement

procedures. Concerns about a change in management of the borrower; standard representations and

warranties and covenants. Prohibition on transfers, even a fractional interest in the borrower.

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Legal Drafting Issues

Inconsistency Between Borrower’s State of Registration and Lender’s Requirements

If the owners are establishing a new entity to serve as the borrowing entity, wait to organize the company until a lender is chosen and any jurisdictional issues are clarified.

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Legal Drafting Issues (cont’d)

The Special Purpose Entity and Independent Director/ Manager Requirements of the Lender

Lender may require title to the property held in a special purpose entity, meaning that it is formed for the purpose of holding this property only, and will not hold other properties or do other lines of business. Independent directors and managers may also be required.

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Legal Drafting Issues (cont’d)

Treatment of Other Creditors, Including Any Mezzanine Lender

Are other creditors or lien holders involved, and will intercreditor or subordination agreements be necessary?

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Legal Drafting Issues (cont’d)

Prohibition on Transfers, including Transfers of Fractional Interests in a Borrowing Entity or

Management

Standard loan documents often contain language that says that the borrower is in default if the property securing the loan, or any interest in the property, is transferred. Since loan documents also provide that if an interest - perhaps even a small interest - in the ownership entity or manager changes, a default will occur.

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Representation of Warranties

• Are the representations and warranties reasonable?

• If not, if you are borrower’s counsel, how should you negotiate?

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Disbursement Procedures

• What are Borrower’s obligations when initiating a request for disbursement?

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Lender liability in CaliforniaRiverisland Cold Storage v. Fresno-Madera Credit Association, 55 C 4th

1169 (2013). This case dealt with a commercial loan secured by real property, but would apply to construction financing. The borrowers were in payment default. The restructuring agreement provided that the borrower would provide additional collateral and the lender would forbear for a period

of time and not commence a foreclosure action. The borrower defaulted again, paid off the loan, and brought an action against the lender for fraud and negligent misrepresentation, as the forbearance period in the restructuring agreement was 3 months, but Borrower

claimed the loan officer stated it was for a period of 2 years. Also, the loan officer had stated 2 parcels of land would be required as additional

collateral, but the restructuring agreement identified 8 parcels. Apparently, the borrower signed the agreement without reading it and

without advice of counsel. The court held that the lender’s extrinsic statements could be introduced to show fraud.

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Dollar Tree Stores Inc. v. Toyama Partners, LLC, 2010 WL 1688583 (N.D. Cal. Apr. 26, 2010).

Dollar Tree Stores Inc. operated a retail store in a shopping center that was in need of renovation. Comerica Bank financed the renovation project with a construction loan to the

landlord. Dollar Tree asserted that the renovation interfered with its business and negotiated a settlement with the landlord. Under the terms of the settlement, Dollar Tree agreed, among

other things, to vacate the premises for a period of time and then to accept replacement premises in the newly renovated shopping center, which would include Dollar Tree and

another retail business as anchor tenants. The settlement also included a $500,000 closing fee to Dollar Tree, financed through the Comerica loan, rent abatement and other monetary

compensation. Before the renovation project was completed, the other anchor tenant terminated its lease, which resulted in a default under the Comerica construction loan. In response to the default, Comerica ceased further funding of the renovation project. The

landlord failed to provide replacement premises in the newly renovated shopping center to Dollar Tree, which violated the terms of the amended and restated lease agreement. Dollar Tree sued the landlord and Comerica under the following claims. Comerica filed a motion to

dismiss, which the Court granted.

The trial court vacated due to settlement of all parties.

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Tortious Interference with ContractThe elements for tortious interference with contract are:

“(1) a valid contract between plaintiff and a third party; (2)defendant’s knowledge of this contract; (3)defendant’s intentional acts designed to induce a breach or disruption of the contractual relationship; (4)actual breach or disruption of the contractual relationship; and (5)resulting damage.”

Dollar Tree asserted that Comerica’s agreement to finance the renovation project was a conspiracy between Comerica and the landlord intended to cause a breach of the original lease and that Comerica’s decision to cease funding caused a foreseeable breach of the amended and restated lease entered into in connection with the settlement. The court held that the facts did not support a “plausible theory” that Comerica intended to induce a breach of either lease.

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Tortious Interference with Prospective Economic Advantage

The elements for tortious interference with prospective economic advantage are:

“(1) an economic relationship between the plaintiff and some third party, with the probability of future economic benefit to the plaintiff;

(2) the defendant’s knowledge of the relationship; (3) intentional acts on the part of the defendant designed to disrupt the

relationship;(4) actual disruption of the relationship; and(5) economic harm to the plaintiff proximately caused by the acts of the

defendant.”

This tort also requires the assertion of an “independent wrongful act” – acts designed to interfere with a contract are not enough. Here, the Court

could find no independent wrongful act by Comerica.

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Breach of Subordination, Non-Disturbance and Attornment Agreement

The subordination, non-disturbance and attornment agreement provided that Comerica would not disturb, diminish or interfere with Dollar Tree’s possession of the leased premises (absent Dollar Tree’s default of the lease). Dollar Tree asserted that Comerica knew the construction loan agreement would interfere with the lease and, therefore, breached the subordination, non-disturbance and attornment agreement. Here, the Court summarily held that it could not “infer that the act of lending money alone would result in a breach of this agreement.”

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Breach of Implied Covenant of Good Faith and Fair Dealing

Dollar Tree asserted that Comerica breached the covenant of good faith and fair dealing implied in the subordination, non-disturbance and attornment agreement by financing a renovation project, which required Dollar Tree to vacate the premises, and by refusing to continue funding after the event of default. The Court dismissed these claims as well, after discussing the scope of the implied covenant of good faith and fair dealing. In the Court’s view, Dollar Tree was attempting to use the implied covenant to impose additional substantive duties on Comerica – specifically, a duty to continue financing even during a default or a duty not to finance a project that may affect Dollar Tree’s operation of the premises.