In most residential and small commercial construction projects, the owner will obtain construction financing through a third-party lender. As part of the loan documentation process, lenders will often require the general contractor to join in the execution of some of the loan documents (e.g., the construction loan agreement), as well as prepare for the contractor's signature a series of ancillary documents designed to ensure the priority of the lender's security documents. Additionally, when the construction loan involves homestead property, the lender will ask the general contractor to sign a "Mechanic's Lien Contract" which is somewhat duplicative of the existing construction contract between the general contractor and the owner. This new contract will invariably contain provisions that conflict with the construction contract already signed by the general contractor and the owner, as well as contain clauses that can significantly increase the risks faced by the general contractor during the construction process. Unfortunately, to the extent these conflicts exist, the lender's documents will control --either because the later agreement supplants the earlier contract, or there is an explicit provision in the lender's documents to that effect.

What are some of the pitfalls in the lender's documents and how can those pitfalls be avoided? First, the general contractor needs to carefully examine the lender's documents and consider their effect on the parties' construction contract and the contractor's op-erating procedures. Some of the areas typically impacted are change order procedures, draw request approvals and timetables and termination procedures. However, merely checking for conflicting provisions will not be enough.

A recent decision from the San Antonio Court of Appeals is instructional. The opinion explains that a builder and a homeowner signed a contract for the construction of a new residence. The lender providing financing for the construction presented a series of documents to the contractor for execution in connection with the loan. One of the documents provided an assignment of the builder's lien rights to the lender. Construction proceeded as planned until the builder sub-mitted its final draw request. As the homeowner was behind on loan payments, the draw request was never paid by the lender and eventually, the homeowner defaulted on the construction loan. After the lender foreclosed, the builder attempted to enforce its lien rights against "removables" in the project to recover the money owed for the final draw request under the contract. The lender countered and the court agreed that the broad and sweeping language contained in the lien assignment transferred all lien rights possessed by the builder, leaving the builder nothing to enforce. MG Building Materials, Ltd. v. Moses Lopez Custom Homes, Inc., 2005 WL 17774153 (Tex. App. -- San Antonio 2005, pet. filed). The lien assignment in that case was not necessarily in conflict with the construction contract; it simply added the lender as a participant to the contract between the owner and the contractor. This type of lien assignment is just one example of the problem clauses that can be found in construction loan documents and demonstrates the need for contractors to be aware of the effects of the documents which they sign.

So, what should the contractor do to avoid this? First, get the documents well in advance of the loan closing so they can be reviewed. Second, explain the practical implications of the documents to the lender and the owner. Third, use the owner's influence with the lender to secure concessions. Most lenders (with their customer's input) are willing to modify the loan documents so they are fair to both the general contractor and owner while still sufficiently protecting the lender's interests.