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March 30, 2016

Best Practices: Documenting Disbursements: Construction Loans

by Jennifer Borra

Documenting disbursements can be a monumental task for SBA lenders on construction loans. SBA cites failure to use loan proceeds as required by the SBA loan authorization as one of the most common lender deficiencies noted in PLP audits and guaranty purchase reviews. Construction loans present a multitude of pre-closing and post-closing challenges for lenders in clearly and accurately documenting the use of proceeds for a construction project. This article briefly examines some of the due diligence documents lenders should consider obtaining at a minimum, to verify use of loan proceeds both pre-closing and post-closing for a construction loan.

Pre-Closing Due Diligence

  • Obtain a fully executed copy of the construction contract
  • Obtain a copy of the final plans and specifications from the borrower
  • Ensure that no construction has commenced prior to initial disbursement of the loan
  • Obtain an agreement from the borrower and contractor that no change orders shall be implemented by the parties without the lender’s prior written approval
  • Engage a construction monitoring firm to verify progress on the project prior to making future disbursements
  • Perform a pre-closing site inspection to verify no work has commenced; alternatively, verify work has been completed and fully paid for (with accompanying lien waivers) if work was paid for by borrower’s equity injection
  • Obtain an agreement from the borrower that lender is not obligated to finance any cost overruns

Post-Closing Due Diligence

  • Perform interim site visits to ensure project status/completion prior to disbursing any funds to contractors
  • Obtain lien waivers from all materialmen, contractors and sub-contractors prior to each draw
  • Proactively review borrower’s financial information on a regular and ongoing basis from the date of closing to ensure there are no adverse material changes prior to each draw

Failure to obtain the required construction documents and perform the necessary due diligence prior to each construction loan advance could result in a repair or complete denial of the SBA guaranty. Lenders must adopt best practices for monitoring their construction credit facilities to minimize the risk of losing the SBA guaranty. For more information regarding construction loan disbursements, please contact Jen at 267-470-1206 or at jborra@starfieldsmith.com.