Construction loan closing entails a host of paperwork
If your business has a simple line of credit with your bank, you probably signed a note, and maybe a security agreement and UCC Financing Statement, and that was the end of the loan closing.
The first time you take out a construction loan to build your company’s new building, you may be surprised to see a sea of documents on the table which must be signed in connection with your construction loan closing. Here is a quick guide to what those documents do and why they are necessary.
Note. Just as with a general commercial loan, the note represents the obligation to repay the borrowed money, and an agreement on the interest rate and how the interest rate may change, the length of the loan, and how and when the loan will be repaid.
Mortgage. In a construction loan, the lender is giving you the money not based on the strength of your business, but on the value of the land you have purchased and the improvements you are constructing. Therefore, the lender takes the property and the future improvements you are creating as collateral for the loan. The mortgage gives the bank a lien on the land and future improvements, explains how you must maintain and insure the property to preserve that collateral, and identifies what the procedure will be if the lender ever has to foreclose.
Affidavit of Liens and Possessions. In Wisconsin, if you buy a piece of property, and a tenant is occupying that property, even if that tenant has no rights recorded in the Register of Deeds’ office, you may take title to that land subject to that tenant’s rights. Part of what the Affidavit of Liens and Possessions does is have the current owner of the property swear that either there are no leases, or has the owner identify exactly who does have lease rights.
The second part of the Affidavit of Liens and Possessions clears a different issue dealing with contractor liens. In Wisconsin, generally speaking, anyone who has either performed work or provided materials for the improvement of your property within the last six months has a right to put a lien against the property.
For example, if your seller had work done on the property the day before he sold the property to you, and the contract was not paid, that contractor might still have the right to put a lien against your property after you purchase it.
In order to clear up such a potential problem, the seller also signs this Affidavit of Liens and Possessions.
The title company can then work forward from that date, to eliminate lien rights for contractors you hire after you purchased the property.
Architect’s and Contractor’s Contracts and Assignment. You probably have already entered into or are in the process of entering into a contract with an architect and/or a general contractor.
One of the construction loan closing documents will be an assignment of those contracts to the lender. Typically, the architect and the contractor contract are made directly with your company and cannot be assigned without the permission of the architect or contractor. However, if you flee in the middle of the project, the lender needs to know that it can use the same architect and the same contractor to finish the project.
A half-built project has very little value, but if a bank can finish the construction of the project, it then has something valuable that it could use as collateral and sell at a foreclosure sale.
Assignment of Permits. Similarly, if you have obtained a building permit or other permits to build your improvements, the lender may also need those same permits to continue the construction project if you stop.
Evidence of Zoning. Either through a letter from your municipality or through a zoning endorsement to your title commitment, the lender often asks for evidence that the building you want to build can be built, and can be occupied for your intended use, in the location and in the manner you want.
Survey. A survey is the only document that provides a link between the paragraph legal description of your property on the deed to you, and the land your eye sees.
The survey usually identifies the boundaries of the property, the correct legal description, the location of any buildings or other improvements that are currently on the property, the location of any easements that are recorded against your property, and any other markings that you have asked the surveyor to perform.
There is no standardized legal definition of “survey” so you need to specify which of these items you want.
In a construction loan closing, the vacant-land survey provides the base point to the lender and title company, showing what is on the land now. Generally, after the foundation and footings have been put in, the loan closing documents may require an “as-built survey” that locates the foundation and footings on the property.
Title Insurance. The title insurance commitment discloses who is the current owner of the land in the official county records, the exact legal description, any other documents that are recorded against the property in the county Register of Deeds’ office, (such as easements and deed restrictions), special assessments levied against the property, and any documents which must be obtained before the title company will issue the policy.
The insurance policy that goes with the title commitment insures each of the owner and the lender against a number of other title problems, and gives you an insurance policy against which you can claim, if the policy fails to disclose a problem it should have disclosed. Most important, it will pay to defend you if anyone challenges your title to the property because of a covered defect.
Construction Loan Agreement. The construction loan agreement, if you have one, identifies what documents you need to provide and what conditions must be met, for the lender to make each construction draw.
Typically, there is a long list of documents required for the first construction draw, which is essentially your closing checklist, and then a list of documents required for each later construction draw. In addition to the as-built survey referred to above, draw requests usually require at least the following:
Draw Request. A draw request signed by the general contractor for payment for completed items, usually on a spreadsheet showing the total budget for that item and how much remains to be completed for that particular item. The contractor usually must sign some type of affidavit swearing that all of the work requested in the draw request has been completed. The owner usually must also sign the draw request approving the payment of those amounts.
Contractor’s Affidavit. The contractor signs an affidavit to the title company confirming all of the contractors and materialmen who have been hired by the contractor to do work on the property since the beginning of the project. That gives the title company the master list of every party who may have lien rights against the project so that they can start collecting the lien waivers from each of those parties and closing off that risk.
Owner’s Affidavit. Often, the title company will also request the owner to sign an affidavit confirming the list of any contractors that the owner has hired directly for work on the project, again, so that the title company has the master list against which to check off all the lien rights.
Inspection. Many lenders require that an inspector, either an independent inspector or a representative of the lender or the title company, must go to the site of the project and view the project to make certain that the improvements that are claimed to have been built actually have been built. The borrower pays for this fee.
Lien Waivers. The contractor, along with his draw request, must provide the title company with lien waivers from his own company, and any subs the contractor has hired, for all of the work that has been completed under his control. If the owner hired subs directly, the owner must follow the same procedure. There is often discussion whether the general contractor must bring lien waivers for all of the work that is requested in that current draw request, or only for the work that was completed through the prior draw request.
Certificate of Substantial Completion. At the time that the final construction draw is made, in addition to all of these documents, the title company and lender usually require that the architect sign a document certifying that the work has been completed in accordance with the plans and specifications that were approved by the lender and any state or local building inspectors
Permits. Because construction cannot proceed legally without securing both state and local building permits, as a condition to the initial closing, the lenders usually require copies of the local building permits and the state stamps on the plans and specifications for the state approvals.
Utility Availability. Lenders typically require some evidence that all of the utilities that are necessary for the project are in the roadway or adjacent to the property.
Occupancy Permits. An occupancy permit is a permit that is issued at the time construction is complete and the building inspector determines to allow the property to be occupied.
Disbursement Agreement. The title company and the lender may require you to sign a Disbursement Agreement, joined in by the general contractor, so everyone has agreed to the same disbursement procedures. Without it, the construction contract’s disbursement procedures often do not match the lender’s.
Nancy Leary Haggerty is an attorney with the Milwaukee office of Michael Best & Freidrich.
May 1998 Small Business Times, Milwaukee
Construction loan closing entails a host of paperwork