Prime Contractor Beware, No. 1: Watch Out For Owner/Lender Consent and Assignment Agreements
Here’s the Scenario:
After months of working with a new developer client (and providing hours of unreimbursed value engineering) and hard negotiations over the cost plus GMP contract (fighting over indemnity/escalation/savings/liquidated damage clauses), you have a deal. You pop a cork with all involved since the developer has said this is one of many future projects. Your very patient subcontractors have held their prices. You have assurances of financing (after all, it’s not the “developer’s” name that’s on the prime contract, it’s the specially created “limited liability” company that’s the “owner”). The Notice to Proceed is forthcoming. But then you receive an email from your developer saying that the construction loan for the project is going to close in two days, and please sign and return the enclosed lender required “Consent Certification and Agreement.” While there’s been zero discussion of such an agreement, certainly none in the prime contract, the pressure is on. You want to be cooperative because if there is no loan, there is no money… and no project.
Don’t blindly sign this “tri-party” agreement (owner, lender, and contractor). It is a binding contract between you and the lender and is applicable if the LLC owner defaults under the loan. While the content of these agreements differs from lender to lender, here’s what they normally contain:
- A contractor consent to a potential assignment of the prime contract to the lender in the event the owner defaults;
- The circumstances under which the contractor will or will notget paid for past and future work;
- A waiver of lien rights for work in place; and
- Obligation on the contractorto seek prior written permission directly from the lender, during the project, and prior to any possible default by the owner, for any change in the plans, the schedule, and even any change orders.
Will this requirement for lender permission be followed during the project? Almost never. But what’s the risk if it does not happen? Suppose there is an owner default. The lender provides formal notice that it’s your “newest best friend” and is stepping into the shoes of the owner. Now, you have “breached” the contractual obligations to provide notice to the lender.
Yes, you have little leverage on the front end. Many times, the lender’s lawyers say to the owner (and then pass it onto the contractor), “No negotiations; get it signed or no deal.” While you may have faith in your hugely successful developer client, again (see above), your contract is with a single use LLC whose only asset is the land that is about to be heavily mortgaged to the lender. If there is an owner default/foreclosure and this agreement is invoked, you may have a fight over payment, completion, and retainage. And if there have been multiple change orders, delays, suspensions, or major changes in scope of work without obtaining lender permission, you better believe the lender will pull out this agreement and argue “material” breach.
What Can You Do?
First, try to negotiate the terms. You cannot get around a basic assignment but try to provide some better language about getting paid for work in place and future work. Do not waive lien rights in advance (which in many states would not be enforceable). Put the burden on the owner to obtain written permission from the lender for any amendments, change in plans, schedule, or change orders. Another option is to try to improve the definitions of the terms. Add “material” to changes in the scope of work. For change orders, propose a monetary amount ($100,000) for the requirement to obtain written permission from the lender. And be prepared for the developer (and their lawyers) to come down on you like a house of bricks for not being a “team player” and potentially screwing up the “deal” that “has to close on Friday.” And don’t worry — “We will never default, so why haven’t you signed the agreement?”
The Bottom Line
In 98% of your projects, there should never be a need to “go back” and read the fine print of the prime contract. But it’s the 2% of the projects that can go sideways that suck every drop of profit out of the rest of the projects. Will such a lender assignment and owner default ever happen? The odds are overwhelmingly no, but just in case, be aware and pay attention to these kinds of agreements. Do not simply sign without reading through the fine points and details. Call your “friendly neighborhood” construction lawyer and get some sage advice about pushing back on some of the terms. If the answer is “no,” then you have a business decision to make. If that decision is to sign, be sure that the entire project team knows about these requirements for advance written permission. And then when the owner (or architect) complains about delays in executing change orders, remind them about the agreement.
Republished with permission. This article, "Prime Contractor Beware, No. 1: Watch Out for Owner/Lender Consent and Assignment Agreements," was originally published on Bradley's BuildSmart blog on October 19, 2022 and republished by NASBP.