construction loan funding and title insurance: best...

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Presenting a live 90-minute webinar with interactive Q&A

Construction Loan Funding

and Title Insurance: Best Practices

in Disbursement and Documentation Drafting Effective Future Advance, Budgeting and Draw Provisions;

Lien Waivers, Title Updates and Endorsements

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

TUESDAY, SEPTEMBER 12, 2017

Peter G. Freeman, Partner, Pillsbury Winthrop Shaw Pittman, Washington, D.C. & New York

Euchung Ung, Partner, Kleinberg Kaplan Wolff & Cohen, New York

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©2017 KKWC All Rights Reserved.

Construction Loan Funding and Title Insurance:

Best Practices in Disbursement

and Documentation Euchung Ung

Member Kleinberg Kaplan Wolff & Cohen, P.C.

212.880.9809 [email protected]


Construction Loans Examples:

• Ground-Up Construction – borrower purchases vacant land or existing developed property and demolishes the improvements, and constructs a new building on the land.

• Renovation or Refurbishment – borrower upgrades an existing developed property, or converts it to a different use, such as recladding an old office building to make it more energy efficient or turning a hotel property into a residential condominium.

• Expansion or Existing Property – borrower adds a new building to an existing property, such as adding a new outparcel building on a pad site in an existing shopping center.

• Tenant Improvements – borrower requires funds to pay for tenant improvement work or for providing tenant with a landlord allowance to perform tenant improvements.

6


• Title and Survey Review – title company and surveyor, with review and analysis by attorneys typically

• Environmental Report – environmental engineers, with review and analysis by attorneys or client if required

• Soil Testing and Engineering – civil engineering, with limited review or analysis by attorneys typically

7


• Title and Survey Review

• Environmental Report

• Soil Testing and Engineering

• Permitting and Zoning Review

• Appraisal

• Construction Budget

• Construction Schedule

• General Contractor and Development Manager Diligence

8


Permitting and Zoning Review

• What can be built now without additional entitlements

• What is the scope of the project

• What additional entitlements are required

• What is the timing and process for obtaining the entitlements

• What is the downside risk of not obtaining the entitlements

• What permits are required to begin construction

• What certificates are required to evidence completion

Lawyers are typically closely involved. Understanding the information its impact is important in the loan documentation process

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Appraisal

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Construction Budget

• Site Costs – purchase price for the land, brokerage commissions, legal fees, title insurance costs, conveyance taxes, borrower’s diligence costs, and costs to prepare the land for development

• Hard Costs – cost of equipment, materials, labor, decorations, furniture, fixtures and equipment, and cabling systems, etc. Depending on the lender, some of these may need to be funded by borrower.

• Soft Costs – examples include developer fees, engineering fees, architect fees, legal fees, marketing expenses, real estate taxes, finance charges, insurance premiums, permit fees, equipment rental fees.

In some jurisdictions, hard costs and soft costs are defined by statute – it is important to understand the statutory law relating to construction costs prior to drafting loan documents.

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Construction Schedule

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©2017 PROSKAUER/KKWC All Rights Reserved.

Other Contracts

• Lien, bankruptcy, tax and UCC searches (GC/Development Manager)

• Bonding requirements (GC/Development Manager)

• Required Insurance (GC/Development Manager/Other Professionals)

• General Contractor’s Agreement (e.g., AIA form or otherwise) or Development Management Agreement

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General Contractor or Development Manager – Legal Aspects

• Lien, bankruptcy, tax and UCC searches

• Bonding requirements

• Required Insurance

• General Contractor’s Agreement (e.g., AIA form or otherwise) or Development Management Agreement

14


Sample list of Loan Documents:

• Promissory Note

• Loan Agreement

• Mortgage

• Assignment of Leases and Rents

• Assignment of Contracts, Licenses and Permits

• Subordination of Development Manager and Assignment of Development Agreement

• Cash Management Agreement

• Non-Recourse (“bad boy”) Carveout Guaranty

• Completion Guaranty

• Guaranty of Payment

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80

20

80

10

10

80

20

20

Lexington Park Avenue Madison

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80

20 20

20

Lexington

20

20

20

17


Park Avenue

34543

80

10

10

80

10 10

10

2.5 20

2.5 20

2.5 20

2.5 20

18


20

40

Madison

20

40

80

20

20

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Sample Cash Management Items:

• Real Estate Taxes

• Insurance

• Loan Interest

See PDF for sample cash management provision.

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Sample Budget Shifting Provision:

See PDF for sample budget shifting provision.

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Sample Draw Request:

See PDF for sample draw request letter.

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Examples of items typically required for Draw Requests:

• Hard Costs Statement - i.e., a reconciliation between the actual Hard Costs and the budgeted Hard Costs

• Soft Costs Statement - i.e., a reconciliation between the actual Soft Costs and the budgeted Soft Costs

• Cost Certification – typically from the General Contractor or Developer, or the Architect

• Payment receipts from the Developer, General Contractor and all Subcontractors

• Proof of payment of all Hard Costs and Soft Costs covered by all previous Draw Requests

• Final Lien Waivers from the Developer, General Contractor and all Subcontractors for all sums advanced up to and including the previous Draw Request (to the extent not previously delivered pursuant to a prior Draw Request or otherwise)

• Conditional Lien Waivers for the current Draw Request – i.e., lien waivers that state the payee waives its lien against the real estate if it receives the specified sum of money

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Customary General Conditions for Advances:

• No lien for the performance of work or supplying of labor, materials or services shall have been filed against the Land and remain unsatisfied or unbonded or as an exception to the title insurance policy insuring the Mortgage.

• No condition or situation shall exist at the Land which, in the reasonable determination of Lender, constitutes a danger to or material impairment of the Property or presents a danger or hazard to the public.

• The representations and warranties made in Article III shall be true and correct in all material respects on and as of the date of the Advance with the same effect as if made on such date.

• All terms and conditions of the Loan Documents required to be met as of the date of the applicable Advance shall have been met to the satisfaction of Lender.

• Lender shall have received all due diligence materials it reasonably deems necessary with respect to verifying the Borrower’s identity and background information in a manner reasonably satisfactory to Lender.

• No Default or Event of Default shall have occurred and be continuing.

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Sample Loan Agreement Retainage Clause:

• Borrower shall (or shall cause Developer to) hold back from amounts payable to the General Contractor under the GC Agreement, and shall cause the General Contractor to hold back from amounts payable to each Subcontractor under each Trade Contract an amount (“Retainage”) with respect to the value of its work in place in respect of the Improvements, which shall not, at any time, be less than (i) [____%] of the aggregate Hard Costs theretofore incurred by Borrower with respect to the General Contractor or such Subcontractor, as the case may be, for work in place in completing construction of the first [____%] of the work to be performed by the General Contractor or such Subcontractor, as the case may be, with respect to the Improvements, as verified from time to time by Lender’s Consultant pursuant to the provisions of this Agreement, and (ii) [____%] of the aggregate Hard Costs theretofore incurred by Borrower with respect to the General Contractor or such Subcontractor, as the case maybe, for work in place in completing construction of the last [____%] of the work to be performed by the General Contractor or such Subcontractor, as the case may be, as verified from time to time by Lender’s Consultant pursuant to the provisions of this Agreement, such [____%] to be based upon the total budgeted Hard Costs for the work to be performed by the General Contractor or particular Subcontractor, as the case may be, as of the date of computation.

• Retainage will be withheld by Lender and released to Borrower upon Completion of Construction concurrently with the making of the Final Advance.

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WAIVER AND FINAL RELEASE OF LIEN Know All Men that in consideration of the final payment (the “Final Payment”) of $[________] (check #[________]), in hand, paid to [________], receipt of which is hereby acknowledged, and other good and valuable consideration by [________], [________] hereby forever releases and discharges [________] from any and all liability, damage, cost, injury, attorney's fees, rights, claims, demands, actions, causes of actions, lien and lien rights which [________] now has or might have against on account of furnishing labor, material or services for or incorporated into the following property:

Client/Owners: [________] Address: [________] [________]

[________] respectfully warrants that the contract status set forth above is an accurate statement, no other sums are claimed, that all laborers, subcontractors, and suppliers employed by [________] have been paid in full all sums. With the Final Payment no such laborers, subcontractors, or suppliers is or will be entitled to claim or thereon for labor or materials furnished to or for the account of [________].

[________]

By:____________________________________ Name: Title:

Date:[________]

Acknowledgments

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Advances for Off-Site Materials

See PDF for sample provision

27


Sample Requirements for Final Advances:

• Lender’s Consultant and the Architect shall have certified to Lender that construction has been completed in a good and workmanlike manner, in accordance with applicable requirements of all Governmental Authority and substantially in accordance with the Plans and Specifications;

• To the extent required by applicable Governmental Authority for the use and occupancy of the Improvements, certificates of occupancy and other applicable Permits and releases shall have been issued with respect to the Improvements and copies thereof have been furnished to Lender.

• Lender shall have received a reasonably satisfactory as-built Survey showing the location of the Improvements.

• Lender shall have received a reasonably satisfactory final affidavit from the Developer or the General Contractor and full and complete releases of lien from the General Contractor and each Subcontractor to the General Contractor with respect to work performed and/on materials supplied in the Project.

• Lender shall have received a reasonably satisfactory set of as-built Plans and Specifications for the Improvements.

• Lender shall have received a reasonably satisfactory endorsement to its title insurance policy.

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Examples of where other Agreements where Construction Draw Provisions would apply:

• Mezzanine Loans

• Development Agreements

• LLC Operating Agreements or Partnership Agreements

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Typical Guarantees in Construction Loans:

• Completion Guaranty

• Loan Repayment Guaranty

• Non-Recourse Carveout Guaranty

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This material is provided for general informational and educational purposes only. The information contained in this material is subject to change without notice. The presenters undertake no obligation to update this material.

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Pillsbury Winthrop Shaw Pittman LLP

Construction Loan Title Insurance Issues Pete Freeman

Kelly Behr

BASICS OF LENDER’S TITLE INSURANCE

33 | Construction Loan Title Insurance Issues

Loan Policy of Title Insurance

A loan policy of title insurance primarily insures that

1. the mortgagor owns the real estate that it is offering

as security for repayment of the loan,

2. the mortgagor has the authority to mortgage the real

estate, and

3. the mortgage has the required priority.


How Title Insurance Companies Mitigate Risk

By performing a diligent and time-consuming search of

land records

Establish a chain of title

Identify encumbrances, including

Liens

Easements

Rights-of way

Future interests


Identifying a Title Insurance Company

Promptly engage a title agent or title insurance company

If two policies are needed, promptly engage a different

title agent or insurance company to spread risk

Once engaged, a title agent or insurance company will

issue a Title Commitment, which will include standard and

recorded exceptions


Title Insurance Policy Endorsements

Loan policies are modified by endorsements

Endorsement availability varies per jurisdiction

Generally, endorsements can do the following:

Remove or modify the exceptions or the standard

coverage

Provide the insured additional comfort re matters that a

title agent is comfortable underwriting (e.g., access,

survey, and contiguity)

Facilitate the assignment of the insured mortgage

Facilitate the draw process


Costs of Title Insurance

The cost is tied to

1. The Amount of the Policy

Owner’s Policy: Issued at acquisition closing in the

amount of the purchase price

Loan Policy: Issued in the maximum amount of the loan

and liability decreases as the loan is paid

2. Endorsements

Price can vary per jurisdiction

Lender’s and Borrower’s counsels should be involved

Future loan increases: Be wary of local rules


Basic Loan Title Insurance Policy Endorsements

ALTA 3.2 (Zoning Land Under

Development)

ALTA 6 (Variable Rate Mortgage)

ALTA 8.2 (Commercial

Environmental Protection Lien)

ALTA 9.7 (Restrictions,

Encroachments, Minerals)

ALTA 17 (Access and Entry)

ALTA 17.2 (Utility Access)

ALTA 18.1 (Multiple Tax Parcel -

Easements)


ALTA 19 (Contiguity – Multiple

Parcels)

ALTA 22 (Location)

ALTA 24 (Doing Business)

ALTA 25 (Same as Survey)

ALTA 26 (Subdivision)

ALTA 27 (Usury)

ALTA 28.3 (Easement Damage

Land Under Development)

ALTA 32 (Construction Loan – Loss

of Priority)/ALTA 33 (Disbursement)

CONSTRUCTION LOANS


Construction Loan Basics

Provided for constructing improvements upon real

property

Disbursed primarily post-closing

Liability (and property value) increase with each advance

over time

Title insurance must insure the lien priority of each

advance


Mechanic’s Liens

Arise when contractors do not receive duly owed payment for

furnished labor, services or materials, typically occurs when a

development project fails

The contractor files a lien against the real property for the

amount owed in accordance with state law.

The priority of the lien typically relates back to the date that the

labor, services or materials were furnished by the contractor.

If a mechanic’s lien is filed, a lender could lose its lien priority in

an advance of loan proceeds if the contractor’s work began

before the advance was disbursed.


Pre-closing Mechanic’s Liens

Three Approaches

1. The title insurer accepts an indemnity from the sponsor

if the claim is for a small amount, is not part of a

pattern and could be paid by the sponsor.

2. The title insurer accepts an indemnity from the sponsor

per an agreement and requires the sponsor to escrow

125% of the claim amount with the insurer.

3. The title insurer requires the borrower to bond the

claim pursuant to local law.


Lender Options in Construction Loan Default

Ensure the liens are paid pursuant to completion or

payment guaranty

Ensure the liens are paid pursuant to payment and

performance bonds

Pay contractors as part of the foreclosure to complete the

project quickly

Foreclose out mechanic’s liens


Scope of ALTA loan policy mechanic’s lien coverage

Certain endorsements extend coverage against a loss of priority of the

insured mortgage to future mechanic’s liens when there is limited or

no priority for the mortgage lien over future mechanic’s liens

ALTA Series 32 Endorsement – 32, 32.1, 32.2

ALTA 33

Title insurance can confirm that the draw process will not create

additional risk of loss of priority

Must remove the standard mechanic’s lien exception from

Schedule B, Part 1

Add the above endorsements

Pending Disbursements Clause


ALTA 32 Series Endorsements

Deletes Covered Risk 11(a), which insures against loss caused by the

lack of priority of the mortgage over a mechanic’s lien that resulted

from work financed by the mortgage that arises before or after the

Date of Policy

Paragraph 3 of each endorsement adds coverage for construction

loan advances but this coverage is subject to

(1) Limitations in the endorsement

(2) Limitations in the policy jacket

(3) Listed title exceptions

Insures the construction loan advance will not invalidate the mortgage

Insures priority of the mortgage over encumbrances missed by the

title insurer


ALTA 32, Paragraph 3(c)

“The lack of priority of the lien of the Insured Mortgage, as

security for each Construction Loan Advance made on or

before the Date of Coverage over any Mechanic's Lien, if

notice of the Mechanic's Lien is not filed or recorded in the

Public Records, but only to the extent that the charges for

the services, labor, materials or equipment for which the

Mechanic's Lien is claimed were designated for payment in

the documents supporting a Construction Loan Advance

disbursed by or on behalf of the Insured on or before Date of

Coverage.”


Other ALTA 32 Versions

ALTA 32.1 Similar to the ALTA 32 but narrower

Insures against the diversion of funds only if the title insurer paid the

contractor directly or gave lender written approval to pay the contractor

ALTA 32.2 Does not require the title insurer or the borrower (with the title insurer’s

written approval) to pay the contractor, unlike ALTA 32 and ALTA 32.1

Like the ALTA 32.1, it only covers payments made directly to a contractor

(i.e. excludes payments to a general contractor, which then pay

subcontractors)

Generally not accepted by lenders but may be necessary if the title

insurer has concerns about the sponsor


ALTA 33

Used in conjunction with the ALTA 32 series

endorsements

Advances the Date of Coverage up to the date of

disbursement

Allows for the inclusion of any new title matters identified

in a title search, including mechanic’s liens

Prudent lenders will disburse construction funds only upon

receipt of a clean ALTA 33


Additional Due Diligence

Title Companies typically require the following information

to issue ALTA 32 series and ALTA 33 endorsements:

Non-start affidavits from the borrower and contractors

Construction contract(s)

Project budget

Construction loan agreement

Subordination from the general contractor to the lender

Evidence of the appraised value

Financial statements


Pending Disbursements Clauses

Added at the end of Schedule B, Part I

Provides that, pending disbursement of the full proceeds

of the loan, the policy insures lien priority only to the

extent of the amount actually disbursed, up to the full

amount of the policy

Allows for the policy coverage to increase as

disbursements are made

Requires that title is examined at the time of each

disbursement so that new liens can be identified and

discharged or subordinated before the disbursement


Summary

The ALTA 32 series endorsements, ALTA 33

endorsement and pending disbursement clause can

insure against mechanic’s liens by tying coverage to a

specific advance made through a process that ensures

that all contractors to be paid from that advance are paid

as required.


Survey Coverage

Coverage is based on the survey provided at closing

Should be sufficient to either

(1) Remove the standard survey exception or

(2) Narrow it to specific matters shown on the survey


Owner’s Policies

Borrower’s counsel should stay involved

Consider the amount to insure

Title insurers recommend an amount that covers the property’s

purchase price plus the value of the completed improvements.

Borrowers often only purchase an amount that covers the

property’s purchase price, so any equity the owner has (or builds

through improvements) in the real property is not covered.

If a borrower purchases an amount that exceeds the property’s

purchase price, the policy will include a pending improvements

clause, which states that the coverage is equal to the actual value

of the improvements at the time of any claim


Sample Pending Improvement Clause

“Pending such time as the improvements contemplated upon

insured premises shall commence, liability under this policy

is limited to the purchase price paid for the land; but as and

when the erection of such improvements shall commence,

liability hereunder shall increase, as the improvements

progress, in the amount of the cost thereof, up to the face

amount of the policy.”


Pete Freeman

1200 Seventeenth Street NW | Washington, DC 20036-3006

(202) 663-8606

[email protected]

Kelly Behr

1650 Tysons Blvd, 14th Floor | McLean, VA 22102-4856

(706) 770-7760

[email protected]


Disclaimer

This presentation is for informational and educational

purposes only. This does not constitute legal advice or legal

opinions. The opinions expressed herein are the opinions of

the presenters only and do not reflect the opinions of

Pillsbury Winthrop Shaw Pittman LLP.
