LIMITATION OF LENDER LIABILITY ON FAILED CONSTRUCTION PROJECT (FLORIDA STATUTE S. 713.3471)

Posted on April 23, 2015April 23, 2015 by Edward Garber

Here is an interesting lender liability dispute by a contractor against a construction lender on a failed construction project with a potentially harsh outcome to the contractor.

In Jax Utilities Management, Inc. v. Hancock Bank, 40 Fla. L. Weekly D948a, (Fla. 1^st DCA 2015), a housing development project went belly up, for lack of a better expression. The developer defaulted under the construction loan and the lender ceased future disbursements under the loan and ultimately foreclosed on its mortgage. At the time of the default and the lender’s decision to cease future disbursements, the contractor was owed in the neighborhood of $500,000. The contractor sued the construction lender for equitable relief: a claim for an equitable lien (presumably as to undisbursed loan proceeds) and for unjust enrichment. For unknown reasons, the contractor did not assert a statutory cause of action against the lender pursuant to Florida Statute s. 713.3471 which details under Florida’s Lien Law a construction lender’s responsibilities under a construction loan and provides in material part:

(2)(a) Within 5 business days after a lender makes a final determination, prior to the distribution of all funds available under a construction loan, that the lender will cease further advances pursuant to the loan, the lender shall serve written notice of that decision on the contractor and on any other lienor who has given the lender notice. The lender shall not be liable to the contractor based upon the decision of the lender to cease further advances if the lender gives the contractor notice of such decision in accordance with this subsection and the decision is otherwise permitted under the loan documents.

(b) The failure to give notice to the contractor under paragraph (a) renders the lender liable to the contractor to the extent of the actual value of the materials and direct labor costs furnished by the contractor plus 15 percent for overhead, profit, and all other costs from the date on which notice of the lender’s decision should have been served on the contractor and the date on which notice of the lender’s decision is served on the contractor. The lender and the contractor may agree in writing to any other reasonable method for determining the value of the labor, services, and materials furnished by the contractor.

(c) The liability of the lender shall in no event be greater than the amount of undisbursed funds at the time the notice should have been given unless the failure to give notice was done for the purpose of defrauding the contractor. The lender is not liable to the contractor for consequential or punitive damages for failure to give timely notice under this subsection. The contractor shall have a separate cause of action against the lender for damages sustained as the result of the lender’s failure to give timely notice under this subsection. Such separate cause of action may not be used to hinder or delay any foreclosure action filed by the lender, may not be the basis of any claim for an equitable lien or for equitable subordination of the mortgage lien, and may not be asserted as an offset or a defense in the foreclosure case.

The crux of the case was whether the contractor could bypass any of the obligations in this statute (including the statutory liability of a lender for not complying with this statute) and assert common law claims against the lender for unjust enrichment and an equitable lien. The First District Court of Appeal firmly said NO! Florida Statute s. 713.3471 precluded the contractor’s common law claims against the construction lender as the contractor’s only recourse, which it did not pursue, was recourse under the statute.

What this means is that if a construction lender disregards the requirements of this statute by not properly notifying the contractor when it elects not to fully disburse loan proceeds, the lender’s liability to the contractor is based solely on this statute. This also means that if the lender complies with the requirements of this statute, it would have no liability to the contractor.

If you are on a failed project, it is imperative to consult with counsel to explore all of your rights and potential avenues of recovery. In this case, the contractor pursued equitable claims against the lender while strategically trying to bypass the statutory requirements and liability of a lender per s. 713.3471. Unfortunately, the First District was not sympathetic to these claims for equitable relief holding that the contractor only had statutory relief per s. 713.3471 and did not have any other relief (that would otherwise be available to the contractor under common law).

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

NOT SO FAST DEVELOPER WITH YOUR CREATIVE EFFORT TO WIPE OUT THE CONTRACTOR’S (INFERIOR) LIEN!

Posted on September 21, 2014September 21, 2014 by Edward Garber

Two things are certain in construction: (1) developers will obtain construction loans to finance the construction of their project and (2) there will unfortunately be bad projects where the developer’s lender forecloses on the (first priority) mortgage given in connection with the construction loan. Not only is this bad for the developer, but it is bad for contractors because the lender will look to foreclose (and wipe out) all inferior liens, such as unpaid contractors and suppliers’ liens (which will be inferior to the lender’s mortgage).

The case of CDC Builders, Inc. v. Biltmore-Sevilla Debt Investors, LLC, 39 Fla. L. Weekly D1997a (Fla. 3d 2014) illustrates a bad project where a lender moved to foreclose on a construction loan. But, unlike a more traditional example of the construction lender foreclosing, this case involved a hyper-creative attempt by the developer to purchase its own construction loan and then foreclose on the corresponding mortgage for the sole purpose of intentionally wiping out its general contractor’s lien.

In this case, the developer hired the contractor to build luxury homes. The contractor completed the homes, but the developer failed to pay the contractor for the last eight homes. The contractor recorded construction liens to collateralize its nonpayment. The developer was unable to pay off its construction loan due to a lack of luxury home sales. To avoid the lender foreclosing, the developer negotiated loan extensions where the developer was required to pay money to reduce the lender’s exposure on the loan. However, the developer did not want its payments to reduce the principal of the loan. Why? Because the developer wanted to ensure there would be no equity in the real property to satisfy the contractor’s liens. So, the developer negotiated with its construction lender to treat any money it paid the lender for loan extensions as junior liens against the property. The developer then had another company created. This other developer-related company purchased the construction loans from the construction lender in exchange for loan assignments. (This was done so the other company maintained a first priority interest with the real property since it purchased the original construction loans.) Once this other developer-related company purchased the construction loans, it moved to foreclose on the loans. Why? Because, by doing so, the developer could wipe out the contractor’s liens as inferior liens on the real property. Very creative and it actually worked as the trial court entered a final summary judgment of foreclosure in favor of this developer-related company (meaning the contractor’s inferior liens would be valueless based on the equity in the real property).

The Third District Court of Appeal reversed the trial court’s foreclosure judgment (as there were questions of fact as to whether the developer-related company was actually created by the same investors that controlled the developer). The Third District, employing a policy of fairness, held that:

“The law does not permit a person to borrow money from a bank, give the bank a mortgage, incur additional liens and junior mortgages on the property, purchase the mortgage back from the bank, and then foreclose on the mortgage for the primary purpose of eliminating the additional liens and junior mortgages.

***

[I]nvestors cannot grant mortgages, contract for the improvement of the property mortgaged, and then use a network of companies to purchase and foreclose the mortgage for the primary purpose of extinguishing the construction liens that increased the value of the property. To hold otherwise would undermine the long-standing principle…persons cannot do indirectly what they are not permitted to do directly.”

CDC Builders, supra.

Stated differently, and less eloquently then the Third District, the law does not permit a developer to undertake creative avenues to purchase the very mortgage and loan it originally obtained to finance its construction for the sole purpose of cheating its contractor out of payment for improving the real property. To find otherwise would simply give the developer a windfall since it would not have to pay for construction improvements that it wanted and which improved the value of its property.

ARGUMENTS FOR LENDER LIABILITY WHEN CONTRACTORS REMAIN UNPAID ON A CONSTRUCTION PROJECT

Posted on June 15, 2011June 15, 2011 by Edward Garber

When a lender provides a construction loan they will have a security interest in the property in the form of a mortgage that should be superior to any construction liens. This is because the lender records its mortgage on the property collateralizing its loan prior to the recordation of the notice of commencement. Since construction liens usually relate back in time and take priority as of the date the notice of commencement was recorded, lenders want to be certain their mortgage was recorded first so that they have the number one priority in the event the borrower / owner does not pay according to the construction loan. This mortgage priority is the lender’s true leverage in the event of nonpayment.

In your typical construction project that is financed through a construction loan, the owner enters into a construction loan with the construction lender. The construction lender immediately records its mortgage on the property and subsequently records the notice of commencement prior to the disbursement of loan proceeds. The owner enters into a direct contract with the general contractor who is responsible for building the project. The general contractor then contracts the trade subcontractors to build various portions of the project.

What happens if a construction projects is halted mid-construction due to an owner not having enough money to complete the project, or a project is finished, but there are contractors that have not been paid for their work? In this situation, contractors that properly preserved their lien rights pursuant to Florida’s Lien Law (Florida Statutes Chapter 713) can record their statutory lien and foreclose on their lien. But…and this is a big but…if there is no equity in the property and the construction lender has number one priority, foreclosing the lien may only result in a pyrrhic victory because there will not be enough equity in the property to pay off the lender and the foreclosing contractor(s). This has been the unfortunate case in a recent economic climate when projects were financed and started during the construction boom.

To illustrate, let’s assume an owner took out a ten million dollar construction loan to build a project and the project was completed or halted mid-construction. The lender recorded a mortgage on the property to secure its loan and disbursed all of the loan proceeds. The owner failed to pay its general contractor one million dollars. However, the project is now only worth seven million dollars due to the decline in property values, and the owner still owes close to ten million dollars to the construction lender. In this case, although the contractor wisely recorded a construction lien, foreclosing on the lien may have little effect. The reason being is that there is no equity in the property so that whoever purchases the property at the foreclose sale–which would be doubtful because the property is worth less than what is owed–is going to take it subject to the lender’s mortgage. The contractor would need someone to purchase the property for at least one million dollars (again, highly doubtful) in order to get paid its principal amount. While the contractor can use its judgment amount to serve as a bid credit to bid and obtain title to the property, this may make little sense if the contractor does not want to pay off the mortgage because it will only be a matter of time before the construction lender forecloses and takes title to the property. Indeed, many times the lender initiates its own mortgage foreclosure lawsuit during the pendency of the contractor’s foreclosure lawsuit and looks to foreclose the contractor’s subordinate lien interest which means there is slim to no chance the contractor is going to recover on its lien.

In this illustration, while the contractor can also sue the owner for breach of contract in addition to foreclosing on its lien, sophisticated owners / developers are single-purpose entities that own nothing but the project they are developing. Stated differently, smart developers form an entity for each project they are building and the entity they establish only owns the property—the same property that is being foreclosed. Or, the developer, if not a single-purpose entity, may not have the capital or assets to pay a one million dollar judgment and essentially be what is referred to as “uncollectible.” Thus, the contractor may be forced to face a difficult reality of having self-financed construction work only to see no avenue of recovery to recoup its expenditures. This is tough to swallow.

However, the contractor may be able to assert creative arguments against the construction lender that would serve as its only true recourse in recovering what it is owed under certain circumstances. Sometimes these creative arguments need to be explored in detail in furtherance of optimizing a monetary recovery.

A. An Equitable Lien on Undisbursed Construction Loan Proceeds

If there remain undisbursed loan proceeds, the contractor may have an argument that it should have an equitable lien on these proceeds if the construction project was completed. The justification being that a lender would be unjustly enriched if it were allowed to keep these undisbursed funds in addition to having the security of the mortgage when the project is completed. Morgan-Oswood & Associates, Inc. of Florida v. Continental Mortgage Investors, 323 So. 2d 684 (Fla. 4th DCA 1975).

To explain, in Morgan-Oswood, a general contractor completed a hotel. The owner, however, breached its construction loan agreement resulting in the lender foreclosing on the property while it still retained undisbursed loan proceeds. The Fourth District Court of Appeal held that: “to allow the lender to retain the undisbursed construction loan funds, while getting the security for the loan as well, would result in unjust enrichment at the expense of the contractor, and the contractor was therefore entitled to an equitable lien against those funds.” Emerald Designs, Inc. v. Citibank F.S.B., 626 So. 2d 1084 (Fla. 4th DCA 1993) discussing Morgan-Oswood.

Additionally, in Emerald Designs, a subcontractor filed a counterclaim against a lender that foreclosed on a project that had been completed seeking an equitable lien on undisbursed construction loan proceeds. The Third District Court of Appeal held that a subcontractor could claim an equitable lien against undisbursed construction loan funds when the construction project is completed and the lender forecloses.

Therefore, if it is determined that the lender did not disburse all of the loan proceeds on a completed project, this argument should be explored.

B. Being Equitably Subordinated to the Priority of the Construction Lender’s Mortgage

Although this is an extremely difficult argument, there may be an argument that the contractor’s lien should be equitably subordinated to the lender’s priority when the lender disbursed all loan proceeds if the contractor can establish the lender engaged in fraud or affirmative deception.

In Rinker Materials Corp. v. Palmer First National Bank and Trust Company of Sarasota, 361 So.2d 156 (Fla. 1978), the lender assured subcontractors that there were sufficient loan proceeds to complete the project and that there would be no need for the subcontractors to record liens. The subcontractors continued to perform work only to remain unpaid. The subcontractors argued that the lender should be equitably estopped from asserting its priority so that their equitable liens could have priority over the lender’s mortgage. The Florida Supreme Court disagreed expressing, “The mistaken observation that there seemed to be enough money left in undisbursed loan funds to complete the project falls short of what we contemplated as ‘affirmative deception’ equivalent to fraud and misrepresentation which would justify the imposition of an equitable lien.” Rinker Materials at 158-59. The Court further elaborated: “We hold that a party may successfully maintain a suit under the theory of equitable estoppel only where there is proof of fraud, misrepresentation, or other affirmative deception. To hold otherwise would inject an unnecessary amount of uncertainty into the construction loan industry.” Id at 159.

This ruling leaves open the difficult-to-prove possibility of claiming a priority position over a lender’s mortgage when the lender disbursed all of the loan proceeds and there is proof of some affirmative deception committed by the lender.

C. A Lender’s Liability under Florida Statute §713.3471

Florida Statutes §713.3471 (contained within Florida’s Lien Law) imposes responsibilities on construction lenders that could expose them to certain liability. Contractors should familiarize themselves with these responsibilities if they remain unpaid, especially if they remain unpaid significant funds due to a project that failed mid-construction.

1. Florida Statutes Section 713.3471(2)

Subsection 713.3471(2) requires a lender to provide the contractor and any other lienor that has given the lender notice to owner (i.e., preserved its lien rights) five business days notice of making its final determination to cease further advances under the loan. The lender shall not be liable to the contractor based upon its determination to cease further advances if the lender gives the contractor notice within five days and the determination is permitted under the loan documents.

Importantly, if the lender fails to provide notice to the contractor within five days, the lender is liable to the contractor to the extent of the actual value of materials and direct labor costs furnished by the contractor plus 15% for overhead, profit and all other costs from the date that the lender’s determination should have been served on the contractor and the date on which notice of the lender’s determination is actually served on the contractor. The lender’s liability is limited to the amount of undisbursed funds at the time the notice should have been given unless the failure to provide notice was done with the intent of defrauding the contractor.

This subsection should be explored when projects cease or fail mid-construction. The point is that the contractor should not continue to perform work when the lender will not be funding the work. This makes sense because contractors don’t want to work for free. Thus, contractors that are involved in a failed project and owed a substantial amount of money should explore the date they received the notice from the lender (assuming a notice was received) versus the date the notice should have been served.

2. Florida Statutes Section 713.3471(3)

Subsection 713.3471(3) applies to the use of designated construction loan proceeds and provides:

“If the lender and the borrower have designated a portion of the construction loan proceeds, the borrower may not authorize the lender to disburse the funds so designated for any other purpose until the owner serves the contractor and any other lienor who has given the owner a notice to owner with written notice of that decision, including the amount of such loan proceeds to be disbursed. For purposes of this subsection, the term ‘designated loan proceeds’ means that portion of the loan allocated to actual construction costs of the facility and shall not include allocated loan proceeds for tenant improvements where the contractor has no contractual obligation or work order to proceed with such improvements.”

Under this subsection, the lender will not be liable to the contractor based upon the reallocation of construction loan proceeds if notice is timely given. However, if the owner fails to provide notice to the contractor and disburses designated construction loan proceeds for any other purpose, the lender is liable to the contractor to the extent of any such disbursements or to the extent of the actual value of the materials and direct labor costs plus 15% for overhead, profit, and all other costs, whichever is less. (Notably, this subsection does not apply to residential projects of four units or less or to construction loans less than $1,000,000 unless the lender has committed to making more than one loan exceeding $1,000,000. The lender is also exempt from liability under this subsection if the total amount of proceeds to be disbursed from the designated proceeds does not exceed five percent of the designated proceeds or $100,000, whichever is less.)

This subsection may come in handy if it is revealed that designated construction loan proceeds were applied for a different purpose to the detriment of the contractor. The point also being that if the contractor knows that designated loan proceeds are being applied elsewhere, they are going to know that there likely isn’t going to be enough money to fund the completion of construction.