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September 16, 2015

Best Practices: An Overview of SBA Construction Loan Requirements

by Starfield & Smith

SBA loan proceeds can be used for ground-up construction, additions, renovations or leasehold improvements. The SBA requires varying documentation based on the kind of construction that is being financed with loan proceeds and the amount of loan proceeds that are allocated to construction.

Evidence of compliance with “National Earthquake Hazards Reduction Program Recommended Provisions for the Development of Seismic Regulations for New Buildings” (“NEHRP”), or a building code with substantially equivalent provisions, is required when a new building is being constructed, when an addition is being added to an existing building, or when proceeds are being used for leasehold improvements that will become permanently affixed to the structure of the leased premises. Evidence of compliance with NEHRP can be provided by certification from a “licensed building architect, construction engineer or similar professional, or a letter from a state or local government agency stating that an occupancy permit is required and that the local building codes upon which the permit is based include the Seismic standards.” SOP 5010(H), page 189-190.

SBA Form 601 is required when construction costs exceed $10,000.00. This form provides a certification from the contractor that it does not engage in discriminatory hiring and firing practices. This form should be executed prior to closing and should be provided to the contractor as early in the process as possible.

When the loan is greater than $250,000 and is collateralized with commercial property on which substantial renovations will be made with loan proceeds, an appraisal estimating the fair market value of the commercial real estate when construction is completed is required. Upon completion, the Lender must obtain a statement from the appraiser, general contractor, project architect or construction management firm certifying that the building was built with only minor deviations from the from the plans and specifications used to determine the as-complete fair market value.

When the construction component of the SBA loan is greater than $350,000.00, the SBA requires evidence that the contractor has furnished a 100% performance bond and labor and materials bond, with Borrower named as obligee on the bond. This requirement can be waived if the disbursement of loan proceeds are controlled by a third party in the business of providing construction management services.

The Contractor must provide Lender with proof that the Contractor carries appropriate General Liability Insurance and Worker’s Compensation Insurance prior to the commencement of construction. Additionally, Builder’s Risk Insurance should be obtained in an amount sufficient to cover the contemplated value of the project and should name Lender as mortgagee and lenders loss payee. Builder’s Risk Insurance should remain in place until construction is completed, at which it point it should be replaced with a conventional Hazard Insurance policy.

The Lender must review the construction contract, which must be a “stipulated sum” or “not to exceed” contract, and which must provide that no material changes in the plans and specifications can be ordered or permitted without the prior written consent of the Lender. Additionally, the Lenders must review a copy of the final plans and specifications for the project. The Lender should use the plans and specifications to make interim inspections at the construction site and to confirm that the project was completed in accordance with the same when construction is finished.

Finally, the Lender must also obtain evidence certifying that the building, when completed, will be in compliance with all applicable zoning ordinances and obtain mechanics lien waivers and releases from all materialmen, contractors and subcontractors.

When Lenders finance construction projects with an SBA loan, they should ensure that they are complying with all SBA construction loan requirements. Failure to comply with SBA’s guidelines for construction loans can lead to repairs or denials of the SBA guaranty. For more information regarding SBA construction loan requirements, contact Sarah at 267-470-1217 or at sminteer@starfieldsmith.com.