How to avoid third party funding issues delaying your commercial construction project

A builder has been selected, the Construction Contract has been negotiated and signed and all the relevant consents required to complete the construction project have been obtained.   Both you and the builders are ready to commence work to meet your deadline.

The only problem –  the funding that you require to undertake your work from the bank is not  available for drawdown and there will be a long delay before drawdown can occur.  A principal in, such circumstances, may not only sustain a commercial loss as a result of such a delay but may also be the subject of a claim by the builder under any Construction Contract signed by the parties.

Arranging third party bank funding for a construction project can be a time consuming and complex task. If third party funding is not treated as an integral part of the construction project and dealt with in a timely manner at the outset of the project, those complexities can stop a construction project in its tracks.

An applicant for construction funding can expend considerable time and effort navigating the complex path required to be undertaken to obtain a letter of offer of finance.  Of course, a would be borrower, may fail to obtain an offer.  Therefore, before you sign a Construction Contract or make any other commitment to a builder you should, as a matter of prudence, ensure that you can fund the entirety of the construction project.

In this regard, even when you obtain a letter of offer from the prospective bank you may still not be lawfully in a position to drawdown on your construction loan facility unless you can satisfy all the conditions precedent to drawdown.  Satisfying these conditions can involve a complexity and period of time that can come as an unpleasant surprise for many applicants.

While the conditions precedent vary from borrower to borrower and reflect the differing circumstances of each borrower, generic conditions precedent required by a third party bank funder to be satisfied before a commercial construction loan facility is available for drawdown will often include the following requirements:

1. The form and content of a construction contract must be satisfactory to the funding bank. Therefore, if you are raising construction funding for a project from a bank, there is no use negotiating a form of Construction Contract with the builder which will not be acceptable to the bank.
2. The total costs of the construction project must be quantity surveyed by a quantity surveyor selected from the funding bank’s panel and the resultant report must be determined to be satisfactory to the bank.
3. The funding bank will often, for larger projects, require the appointment of a project manager or superintendent who must be approved by the funding bank.
4. The builder must be approved by the funding bank and be satisfied that the contractor has the necessary experience and track record in undertaking construction projects of the nature you are seeking to fund under the loan facility.
5. You will often need to provide the funding bank with a property development budget acceptable to the bank.
6. The funding bank will often require not only yourself, but also the builder, to enter into a “Tripartite Agreement” with the funding bank. The objective of this document is to effectively protect the position of the funding bank should you default under the construction loan facility, default under the Construction Contract or you become insolvent. For example, the document will usually grant the funding bank the right to “step in” and conduct the project on your behalf and to assign your rights under the Construction Contract to a purchaser who buys your property at a mortgagee auction undertaken by receivers appointed by the funding bank.  It is not unusual for an owner who has not made it clear to a builder at the outset that the builder will be required to sign such a document to be left as the “piggy in the middle” between the builder and the bank as they dispute the terms and conditions of this document.

These are by no means the only conditions that you may have to satisfy in order to drawdown on your construction funding.  There are, in particular, financial conditions and covenants that may also need to be satisfied and, perhaps, further conditions that reflect your specific circumstances.

The lesson in this is to work with a funder early and to seek clarification at the earliest possible time so as to ensure that you will be in a position to undertake the project with the builder in accordance with the timeframes you are contemplating.  Failure to do so can prove to be a costly mistake.

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This Newsletter is produced by Pigott Stinson. It is intended to provide general information only. The contents of this Newsletter do not constitute legal advice and should not be relied upon as legal advice. Formal legal advice should be sought from us in respect of the matters set out in this Newsletter. Liability limited by a scheme approved under Professional Standards Legislation.