Florida Construction Law Authority : Florida Construction Lawyer & Attorney: Becker & Poliakoff Law Firm: Construction Law

A lender who becomes the seller of new homes acquired from his defaulting builder or developer may be exposed to liability for construction defects whether or not the lender actively participated in any aspect of the original construction.  The actual sale of the home or condominium to the buyer gives rise to the liability under the implied warranty of habitability.  When a lender or bank’s role expands to that of seller, the new role carries increasing liability.

When a lender takes title to a foreclosed home or condominium and completes construction, that lender is under a duty to act with reasonable care in completing construction.  If the lender fails to exercise reasonable care, he may also be held liable for construction defects arising from his negligence. 

Many courts have expanded liability beyond the items that the lender actually completes, and have made the lender liable for other aspects of the project.  In Chotka v. Fidelco Growth Investors, a condominium homeowners’ association sued the construction lender for defects in construction of the project. The lender had taken title to the project when the developer defaulted on its construction loan. When the lender acquired the project, the building was complete except for several recreational features, such as a pool, sauna, tennis court and game room. After these amenities were completed by the lender, the lender sold units to purchasers. The court found that by completing the project and selling the units to consumers, the lender took on more duties than just a financier. The lender was found liable for (1) all express representations made to purchasers, (2) patent construction defects in the entire project, even if completed by the defaulting builder, and (3) breach of applicable warranties due to defects in the portions of the project the lender completed.

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A lender who becomes the seller of new homes acquired from his defaulting builder or developer may be exposed to liability for construction defects whether or not the lender actively participated in any aspect of the original construction. The actual sale of the home or condominium to the buyer gives rise to the liability under the implied warranty of habitability.  When a lender or bank’s role expands to that of seller, the new role carries increasing liability.

When a lender takes title to a foreclosed home or condominium and completes construction, that lender is under a duty to act with reasonable care in completing construction.  If the lender fails to exercise reasonable care, he may also be held liable for construction defects arising from his negligence. 

Many courts have expanded liability beyond the items that the lender actually completes, and have made the lender liable for other aspects of the project. In Chotka v. Fidelco Growth Investors, a condominium homeowners’ association sued the construction lender for defects in construction of the project. The lender had taken title to the project when the developer defaulted on its construction loan. When the lender acquired the project, the building was complete except for several recreational features, such as a pool, sauna, tennis court and game room. After these amenities were completed by the lender, the lender sold units to purchasers. The court found that by completing the project and selling the units to consumers, the lender took on more duties than just a financier. The lender was found liable for (1) all express representations made to purchasers, (2) patent construction defects in the entire project, even if completed by the defaulting builder, and (3) breach of applicable warranties due to defects in the portions of the project the lender completed.

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A recent Florida appellate court decision extended a lender’s liability to contractors for failure to fully fund a construction loan on a project. §713.3471 of the Florida Statutes makes construction lenders liable to contractors and lienors who served a notice to owner if the lender ceases funding a construction loan without first notifying the contractor and lienors. In that situation, the lender could be liable for the actual construction costs incurred plus 15% for overhead and profit from the date on which the notice should have been provided until the date it actually is provided, if at all.

In an opinion not yet reported, Whitehead v. Tyndall Federal Credit Union, the court liberally interpreted this statute to make a lender liable to the original contractor when the lender failed to pay that contractor, but instead paid a replacement contractor. The lender denied liability, saying it fully funded the construction loan as required by the statute, even though the funding went to a subsequent contractor. The court held that, since the construction loan funds didn’t all go to the original contractor, the lender was required to provide statutory notice to the contractor that loan proceeds would no longer be funded to that contractor, even though they would later be paid to the subsequent contractor. The court reversed summary judgment in the lender’s favor, paving the way to the lender’s potential liability to the contractor for actual costs plus 15% overhead and profit.

Therefore, in this environment where non-payment of contractors has proliferated, consideration should be given to whether claims against the construction lender are available
 

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There are some circumstances in which a lender may be directly liable to third parties for construction defects as a principal or alter ego of the developer.  Most jurisdictions hold that for this liability to exist more than just the holding and protection of a security interest and the monitoring of the developer’s operations must exist.  A form of this liability may be found when the developer and the lender are partners or joint venturers. Banks and financing institutions may be held liable to home and condominium buyers if the lender has participated in the management of the project to a degree that the court finds that the lender-borrower relationship was a joint venture.  Also, when the lender assumes control of the contractor it will usually be bound by the construction contract.  If the developer notes construction deficiencies and the lender refuses to withhold disbursements without investigation, the lender may also be liable.

Lender as De Facto Developer
Closely related to the theory of direct or joint venture partnership liability is the theory that the lender is liable to third parties for construction defects because of the control it exercises over the developer’s day-to-day operations.  A lender is considered a developer when it is also involved in the development of the homes sold to the purchasers.  Similarly, a lender is presumably a joint venturer when the lender has an equity ownership in the project with another entity.  Likewise, a lender is deemed to be amalgamated if it merges with a developer or builder so as to appear to be a united entity.  The issue is one of “control.”  By controlling the developer the lender in effect becomes the developer of the construction project.

Banks and financial institutions that limit their involvement in construction projects to financing will not be found liable under a lender liability theory.  However, when the bank takes over the project and constructs or finishes construction as if it were its own, or has some direct involvement, the lender can be held liable for construction defects. 

Subsequent Developer
The issue of de facto developer is further complicated when dealing with Community Associations because lenders can become a “Successor Declarant.”  In cases involving lenders as Successor Declarants, the courts are faced with evaluating the extent to which the lender should be required to fulfill the obligations of the original developer.  When making loans on condominiums or planned unit developments, lenders should consider including “Successor Declarant” language in the documents that more clearly define the rights and obligations of the parties if the original developer conveys the remaining portion of the project to the lender or to another successor.  Successor provisions are beneficial when the facts of the law result in the successor being deemed responsible for fulfilling the obligations of the original developer.  Whether such a provision would limit a successor’s liability for construction defects will depend on the facts and circumstances and the laws of the jurisdiction where the project is located.

A special situation arises when the lender is forced to foreclose or takes the deed in lieu of foreclosure on a construction project.  In our current economically distressed real estate market, an increasing number of lenders are forced to acquire new homes and condominiums from defunct builders and developers and lenders should be aware of potential liability if they become the vendor of these homes.  The seller of a new home (whether it’s a developer or a lender who has acquired a property through foreclosure) impliedly warrants the habitability of the home or condominium.

Stay tuned for more on this issue.

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 With the financial and mortgage market fallout, home and condominium sales throughout the country are taking a hit. Many home and condominium developers have defaulted on construction loans resulting in an explosion of distressed projects. Lenders face the prospect of foreclosing on residential property developments that are in various stages of construction as a consequence of the downturn of the residential real estate market and developer defaults. The foreclosing lender may acquire completed projects or may wish to complete construction before the homes or condominiums can be sold.  Due to the conflicting and complicated issues involved, financial institutions in today’s market face a daunting task deciding whether to foreclose on a construction loan and what to do with the property upon foreclosure.  Not only does the lender have to consider the factors ordinarily involved in the foreclosure process, the lender also has to consider the exposure to liability for construction defects when it steps into the shoes of the developer. 

In most jurisdictions, a mere lender is not liable to the purchaser of a new home for construction defects. Instead, the buyer traditionally looks to the builder or contractor for relief in tort or contract for construction defect claims. However, with the ever-increasing role of construction lenders, the question arises as to whether the buyer's contract and statutory remedies should extend to the lender.

Each situation is different. Depending on the level of involvement, lenders may become a joint venturer with the developer, a de facto developer, or a successor developer, all of which have varying levels of liability for the lender. Stay tuned for more on this issue.

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