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August 2, 2017

Best Practices: Documenting Small Construction Projects Under $350,000

by Michelle Sergent Kaas

SBA guaranteed loan proceeds may be used to construct or renovate buildings. The SBA provides specific requirements for SBA guaranteed loans where the construction component of the loan is more than $350,000. For small construction projects where the construction component of the loan is less than $350,000, the SBA has more relaxed requirements. However, even if the construction component is very minor, the lender still needs to ensure that the SBA requirements are met in order to protect its guaranty. The following is a brief review of SBA requirements for documenting small construction projects under $350,000.

When using loan proceeds to construct a new building or to build an addition to an existing building, even if the construction component is less than $350,000, the lender must obtain evidence of compliance with the “National Earthquake Hazards Reduction Program Recommended Provisions for the Development of Seismic Regulations for New Buildings” (NEHRP) or a building code that has substantially equivalent provisions.

If the borrower will be utilizing a contractor to complete the renovations to the building, then the lender will need to obtain a completed SBA Form 601 from each contractor whose work exceeds $10,000.

If the borrower intends to complete the renovations itself, then a more in depth analysis is needed to determine if this is acceptable under the SOP. The SBA generally frowns upon “do-it-yourself” construction projects, including installation of machinery and equipment, as they “have proven to be generally unsatisfactory and can cause problems with lien waivers and mechanics liens, causing potential losses to lender and/or SBA.” SOP 5010 5 (I), Subpart B, Chapter 5, § VI(D). The SBA therefore only allows proceeds to be used for “do-it-yourself” construction projects if certain requirements are met. Per SOP 5010 5 (I), Subpart B, Chapter 5, § VI(D), the borrower can only act as its own contractor if the lender can justify and provide documentation in its loan file that:

  1. The borrower/contractor is experienced in the type of construction and has all appropriate licenses;
  2. The cost is the same as, or less than, what an unaffiliated contractor would charge as evidenced by 2 bids on the work; and
  3. The borrower/contractor will not earn a profit on the construction.

Regardless of who is completing the work, the lender should request invoices for all work being completed to ensure that the work is in compliance with the SOP and Authorization. If there is a contractor involved, the lender should consider disbursing funds directly to the contractor to ensure that the proceeds are used in compliance with the SOP and the Authorization. If invoices are not available at the time of closing, it is recommended that the lender hold back the funds for the renovations and only disburse these funds after receipt of approved invoices as opposed to giving a lump sum to the borrower at closing. That way, the lender can monitor the use of proceeds, obtain any required SBA Form 601 and ensure that the borrower is not doing the work itself unless it has been expressly approved to do so.

This article only contemplates small construction projects. For construction projects exceeding $350,000, please see the SOP for SBA requirements for projects of this size.

For more information on documenting small construction projects, contact Michelle Sergent Kaas at 267-470-1167 or via email at mkaas@starfieldsmith.com.