Fourth Quarter , 2010

Conventional wisdom among construction lenders holds that a first mortgage is bulletproof to claims by contractors, subcontractors and suppliers. The belief, generally, stems from the fact that lien claimants are subordinate to the construction mortgage and can be “foreclosed out”. The conventional wisdom is usually right.

In these challenging times, lawyers for lien claimants are utilizing creative arguments to extract settlements from lenders. Some lawyers have dusted off the statute book and started to rely on Section 713.3471 of the Florida Statutes which requires a lender to give all known lien claimants notice of the lender’s “decision” to stop funding construction. The term “decision” is unfortunately not defined. If the lender fails to give the notice, the lender is responsible for all out-of-pocket expenses of the lienors, plus fifteen percent (15%) profit, but the damages cannot exceed the undisbursed loan proceeds.

A related scenario occurs when the lender does not disburse all of the loan proceeds, the borrower defaults and the construction is complete. Conventional wisdom would suggest that the lienors are out of luck since the owner/borrower is down and out. The Courts, however, in appropriate circumstances, have created a remedy and allowed the lienors to assert an “equitable lien” against the undisbursed loan proceeds.

Finally, the normal relationship between a lender and borrower is at “arm’s length”. Where, however, the lender and borrower share a close relationship and the lender exercises excessive control over the construction project, lienors may take the position that the lender and borrower are, in reality, partners or joint ventures with joint liability for the construction costs.

As with most legal issues, the outcome depends on the facts. However, the cost of developing the facts, and uncertainty as to the ultimate facts, affect decision making for lenders and lienors. These difficult times will continue to unearth little used legal theories, which create traps or opportunities, depending on your perspective.

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