What happens when a borrower has earmarked portions of a construction loan for specific purposes but those designated funds are then subsequently disbursed by the lender for another purpose?
Florida statutes require that where there is a loan with “designated construction loan proceeds,” the borrower may not authorize the lender to disburse such designated funds for any other purpose unless and until written notice of that decision (including the amount of the designated proceeds that will be disbursed differently) is properly served on the contractor and any other lienor, materialmen or subcontractor who has provided the borrower a Notice to Owner. The term “designated construction loan proceeds” is defined in the statute as that portion of the loan allocated to actual construction costs of the facility, not including allocated loan proceeds for tenant improvements where the contractor has no contractual obligation or work order to proceed with such improvements. If this required notice is timely given and the decision is otherwise permitted under the loan documents the lender is not liable to the contractor for the reallocation or disbursement of the designated loans proceeds. So, for example, if an entire loan, including amounts which the borrower may designate for pre-development work, is fully funded but there are contractors who are not paid in full for their pre-development work, those contractors may have a claim if the notice to reallocate the designated construction loan proceeds for pre-development work was never provided to them by the borrower as required.
Furthermore, the statute provides that if the lender is permitted under the loan documents to make disbursements from the loan contrary to the original loan budget without the borrower’s consent, the lender becomes responsible for serving such notice on the contractor and other lienors. A lender which fails to provide this mandatory notice prior to disbursing the designated construction loan proceeds, including amounts earmarked for work other than that originally budgeted, could be exposed to liability.
Can a Contractor Waive Their Right to Receive?
A contractor or other lienor may not waive this right to receive notice under this statute; however, the statute referenced only applies to residential projects greater than four (4) units and to construction loans greater than $1 million (unless the lender has committed to make more than one loan, the total of which loans are greater than $1 million). As well, neither the owner nor lender is required to give notice to the contractor or any other lienor unless the total amount of funds improperly disbursed by the lender of the designated construction loan proceeds exceeds 5% of the original amount so designated or $100,000.00, whichever is less.
The statute does goes on to state that any disbursement of loan proceeds contrary to this subsection (ie: distributing designated construction loan proceeds for another purpose and failing to give the required notice) renders the lender liable to the contractor (for the lesser of either any such disbursements or the actual value of the materials and direct labor costs plus 15% for overhead and profit.
The contractor shall have a separate cause of action against the lender for damages sustained as a result of the disbursement of loan proceeds in violation of this subsection and this action cannot be used to delay any foreclosure action filed by the lender, may not be the basis of any claim for equitable subordination of the mortgage lien and may not be asserted as an offset or a defense in the foreclosure case.
Lender liability is a very real risk when a lender alters the disbursement scheme of designated loan proceeds, especially when such modification is done contrary to the noted statutory mandates.