Construction is a capital intensive enterprise. Access to borrowed capital is critical for project owners and contractors alike. But a loan must be secured with collateral such as real estate of anticipated contract proceeds. And security interests sometimes create conflict among the various parties on the project. This was illustrated in two recent cases.
A construction lender to a project owner held a security interest in the project real estate. The lender’s collateral increased with the ongoing improvement to the property. The project went over budget and the lender disbursed the remainder of the loan proceeds to the owner with the project only 75 percent complete. The lender did not inform the contractors who continued to work until substantial completion. The project owner didn’t pay the contractors. But when the construction lender foreclosed, it took the property free and clear of the mechanic’s liens of the contractors who had improved the property.
In another case, a subcontractor borrowed operating capital from a bank, secured by the anticipated payments from the subcontract. The prime contractor agreed to name the bank as a joint payee on all the subcontract progress payment checks. The prime then started also naming the sub’s subcontractors and suppliers as joint payees. The bank complained that its collateral had been impaired. Yet nothing in the joint check agreement prohibited naming other payees.
What are your thoughts on security interests on construction projects?
Is it inevitable that the security arrangements made by one party will affect the interests of other parties on the project even though they had no involvement in the arrangement? Are there ways a party can protect itself?
Featured in next week's issue of Construction Claims Advisor:
- No Trade Secret Protection for Pricing Information in Proposal
- Required Information Had to Be Presented in Orderly Fashion
- Lower-Tier Subcontractor Too “ Remote” for Payment Bond Protection
Bruce Jervis, Editor
Construction Claims Advisor