Tip of the Week
Mitigating Risk - Disbursement of Construction Proceeds
Construction lending can be a slippery slope when protecting the SBA guaranty. The lender must make sure to "do it right" and control the disbursement as strictly as possible. It is not about "power", it is about building the building, getting paid and not having legal issues. If the lender does not have the expertise or the resources to overcome the risks of completing the construction project, several instances could occur to cause a repair of the guaranty which could include:
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Subcontractors not getting paid, causing mechanics liens to be filed ahead of the lender's lien (the amount of the mechanic lien could possibly equal the amount of a repair to the guaranty).
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Loan proceeds running out before the construction project is complete (meaning the construction contract was not monitored properly against the actual loan disbursements).
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Not complying with SBA loan authorization requirements of disbursing proceeds exactly as depicted in the construction contract.
Construction loans almost always have times when the project has unexpected changes (change orders) that cause the total project cost to be increased. How is the lender supposed to keep the project in balance? (Construction budget (actual use of proceeds) + injected equity = total construction amount)
For larger construction projects (over $350,000), SBA imposes a number of requirements when the SBA guaranty will be put in place at the beginning of the construction:
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100% performance bond and labor and materials payment bond
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Evidence that the contractor carries appropriate Builder's Risk and Worker's Compensation insurance
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Evidence that the borrower has injected the required construction funds into the project prior to the disbursement of the loan
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Copy of final plans and specifications
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Copy of construction contract
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Obtain lien waivers or releases from all materialman, contractors and subcontractors
SBA also requires the lender to obtain evidence of the borrower's ability to pay cost overruns or additional construction financing expenses. The lender must also make interim and final inspections to determine that construction conforms to the plans and specs. Lastly, the lender must obtain evidence that the building (when completed) will comply with all state and local building and zoning codes; and applicable licensing and permit requirements.
That is a LOT of responsibility.
SBA now allows the lender (with the issuance the SOP 50 10 5) to waive the payment and performance bond, if the lender chooses to hire a third party construction monitoring firm.
Even if you decide to provide conventional construction financing (without the SBA guaranty in place) and then use the SBA loan as "take out" financing, the lender still is at risk to do it right. Required documentation in this instance includes evidence that:
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the contractor has completed construction
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all elements of the construction are paid in full
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the borrower occupies the property
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the property complies with all zoning and necessary governmental permit and licensing requirements
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no unpaid labor or material liens exist (get ALTA title insurance)
Make sure you have the SBA loan number for a PLP processed loan before the conventional construction loan is disbursed.
Regardless of how the lender decides to proceed (bond vs. construction monitoring firm) on the larger projects and proper due diligence (taken in the hands of the lender, possibly) on the smaller projects, prudent lending and a very good understanding of how to properly mitigate the risks associated with construction lending is paramount. We will be adding yet another new and powerful tool to assist you with your construction loan projects, click here for more information.
We at sbaAccess provide training on all the aspects of construction lending and disbursement, click here for more information. This could be conducted remotely with a webcast (2-3 hours of good discussion) or with classroom training (where we would include detailed case studies and participation by representatives from construction monitoring firms to present actual experience in the field). Course modules include:
- SBA construction requirements (loan authorization compliance)
- Closing and funding requirements (specific to construction and renovation)
- Construction risk management (protecting the guaranty)
It would be our pleasure to spend time with your closing/funding (and/or servicing) personnel to assure a good understanding of SBA requirements for construction projects. If your institution is doing a lot in construction lending (risk automatically follows these types of deals), let us help you with your training needs.
Take the Right Approach.
Karen McHugh and Brian Burke
SBA Access ©2009 - All Rights Reserved
All content is copyrighted and unauthorized use is strictly prohibited. If you would like to quote any part of this text, email bburke@sbaaccess.com or kmchugh@sbaaccess.com for permission.
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