United States: Mid-Construction Refinancing: Opportunity Or Plunge Into The Void?

Last Updated: January 2 2015
Article by Michael J. Feinman and Beth A. Bernstein

Construction loans typically do not get refinanced before a project is completed. A construction loan is short-term in nature and both the lender and its customer expect that they will stay on the project until the project is complete, following the ground rules and administrative framework they negotiate. There are some occasions, however, where mid-construction refinancing makes sense, particularly in the current environment where financing conditions are improving and more lenders are willing to finance projects in desirable markets (such as New York City) on better terms than were available a short time ago. Some projects that are currently underway were started when the markets were tighter, and are now better able to attract loans on more favorable terms.

A lender who steps into a project in mid-course is a newcomer to a party that has already started: the borrower, its architect, contractor, and sub-contractors have already negotiated their arrangements, and have established requisition and other procedures with the now exiting lender. Whether the new lender will be welcomed to the party is uncertain, and separately (and potentially more troubling), there may be surprises that the newcomer will have to face lurking beneath the surface.

General Construction Lender Risks

Construction and its administration can be a rough and tumble process. There is an inherent tension between construction lenders, on the one hand, and design and construction companies, on the other hand, both seeking to protect their ability to recover as much as they claim entitlement to, ahead of other claimants, if a project fails to proceed as planned. New York's statutory scheme—embodied in the Lien Law—strikes an uneasy, and often unwieldy, compromise between the competing interests of the construction trades and banks and other construction lenders.

Funds received by an owner as advances under a "building loan contract" (i.e., a construction loan agreement) are trust assets under a statutory "trust fund" created by the Lien Law, for the benefit of those whose labor and materials improve real property, and the statute requires owners to act as trustees and to apply such assets for payment of the "cost of improvement" and for no other purpose. Included in the definition of "cost of improvement" are labor and materials, a number of other construction-related items, as well as interest and principal on building loan mortgages.

The main lender risk imposed by the Lien Law arises under Section 22, which requires that a building loan contract contain a statement sworn to by a borrower representative— known as a "Section 22 Affidavit"—which sets out all expenses to be incurred in connection with the improvement, as well as the remaining amount, representing the "net sum available to the borrower for the improvement." If the requirements of Section 22 are not complied with, the consequences are severe—the parties to the building loan contract (most notably the mortgagee) lose lien priority to a permitted lienor's subsequently filed lien. Thus, although the lender does not sign the Section 22 Affidavit, the statute puts the lender at risk if either (1) the contents of the Section 22 Affidavit are false, or (2) the proceeds of the building loan are not applied in accordance with the Section 22 Affidavit.

Another lender risk relating to construction loans is the risk that amounts paid to a lender will be required to be disgorged as improperly diverted trust funds. The owner, and not the lender, is generally charged with responsibility for maintaining the trust assets and ensuring that they are properly applied for the "cost of improvement." However, if trust funds are diverted, or are paid to payees in an improper order of priority, the recipient can be forced to return them, even if the recipient had no knowledge of the improper diversion. Fortunately, the Lien Law provides a relatively clear route for a lender to avoid a diversion-of-trust-assets claim, by permitting a lender who expects to receive funds from the borrower in repayment of its loan to file a "Notice of Lending" under Section 70 of the Lien Law, specifying the advances it is making to the borrower for which it expects to receive payment out of the statutory trust funds.

Another possible trouble area relates to modifications of building loan contracts. Under the Lien Law (also Section 22), any modification of a building loan contract must be filed within ten days after it is executed and, although not specifically prescribed by the statute, the filing offices (the applicable County Clerk) generally require a newly sworn-to Section 22 Affidavit to be submitted at the time a building loan contract modification is submitted for filing. Even if the parties abide by the filing requirements for a building loan modification, however, the parties cannot modify an existing building loan contract to adversely affect the rights of a party (i.e., a trust fund beneficiary) who is entitled to rely on the original terms of the filed building loan contract. For example, if the lender and borrower determine that the hard cost budget will be reduced, and the interest reserve increased, a contractor (a beneficiary of the Lien Law trust) who is not a party to the modification would be able to claim reliance on the higher number specified in the originally filed building loan agreement.

Construction lenders and their counsel are (generally) careful to prepare and file the proper documents to protect the lender against the risks of violating the Lien Law and to be in a position to properly defend a Lien Law claim by a contractor or other party.

When a lender steps into a mid-construction loan, it is exposing itself to as yet unasserted claims—including lien subordination, trust asset diversion and others—relating to the project. Before stepping in, the lender should do as much as possible to identify any issues, obtain information, and receive assurances from potential claimants that eliminate or reduce the risk of future claims relating to the exiting lender's regime.

Due Diligence and Administration Challenges

As construction loans are administered, the lender and its advisors (inspecting architects and, as needed, counsel) review monthly requisitions and periodic progress reports to determine how the project is proceeding. As part of the monthly requisition process, the lender obtains lien waivers, certainly from the general contractor or construction manager, and probably from identified "major subcontractors." Also, as part of the monthly draw process, the title insurer issues a title continuation, which indicates whether any mechanic's or other liens have been filed. If there is unsatisfactory work, design and field changes, or delays, the lender team is apprised of them, but may not always detail them exhaustively. Moreover, if things "all in all" seem to be progressing, a lender will often defer taking enforcement action, or threatening to do so, in the hopes that the ship will right itself.

When a lender steps into a partially completed project, it must be mindful that the parties may have accumulated issues that require ongoing dialogue and negotiation. Things may have deviated from the original plan, as they often do, with the parties understanding, more often informally, that they will re- visit and reconcile identified issues in a later month. The task of the replacement lender is to understand both the written record and the rest of the story that may be unwritten.

Although the exiting lender would be a good source of information, it is likely to be uncooperative. First, normal commercial prudence (and advice of counsel) will likely dictate that the exiting lender make as few representations as possible. Perhaps more importantly, the exiting lender may be being replaced unwillingly, for example because the new lender's terms are better, giving the exiting lender an added disincentive to cooperate. This dynamic may change somewhat if the exiting lender is itself eager to make an exit.

How then can a replacement lender get comfort that it is not stepping into a mess? It can require that copies of the entire draw package for each advance be delivered to it by the borrower, as they were delivered to the exiting lender. It can inquire of the title insurer whether it has omitted (insured over) any recorded mechanic's liens either currently or in the course of construction. While "insurance over" is a matter that should be disclosed to the insured (the lender and the borrower), there are instances where title insurers will issue a clean title continuation based on an indemnity (or other underwriting consideration) from the borrower (who is in many instances the party with the relationship with the insurer or its agent). If a lien has been insured over, a subsequent lien that is not insured over will "date back" to the earlier filing date, as a matter of law. The new lender may insist that a new title insurer be brought in, to give the project a fresh start, but the feasibility of pursuing this course may depend on the extent to which existing insurance arrangements will be retained or replaced and may be driven by cost.

The new lender should also review with care the existing architect and construction documents. The borrower and its representatives can be counted on to press the new lender not to "reinvent the wheel" and to accept the arrangements that are in place. There are wide variations in the marketplace relating to the level of scrutiny of design and construction documents, and the lender protections that are required. If the original lender was careful and well-represented at the time of the original loan closing, the architect/ engineer and construction contracts will have been reviewed for adequacy, and collateral assignments, including "will serve" agreements, will have been executed by the design and construction parties, and consented to by the borrower. Assuming these documents are determined to be adequate and are by their terms assignable to, or run to the benefit of, a successor lender, they can continue to operate for the new lender. If any inadequacies are identified, the new lender can require modified or new agreements.

Even if the existing documents are strong, it may be appropriate to "downdate" some of the representations and other statements by design and construction parties, to reflect changes to the project design, budget, or scope of work since the time that the original loan closed. For example, a statement by the architect that the plans and specifications comply with law may have been accurate when issued, but may not apply to a set of plans that has been modified internally since the original closing date.

In addition to satisfying itself with the existing arrangements, it is crucial for the new lender to obtain from the main design and construction parties an estoppel certificate or other document that speaks as of the date of the new lender's arrival. The new lender is entitled to know that the contracts it is reviewing have not been modified and that there are no claims that the contractor (or design professional) has for unpaid amounts, additional work, or for matters that were agreed to be addressed or resolved at a future date. Also, because the design and construction parties are beneficiaries of the Lien Law's trust provisions, if the new lender is modifying the building loan contract or anything else agreed to by the exiting lender, it should get the express consent of the applicable design and construction parties to the modification, to ensure that they agree to be bound by what the lender new and borrower are agreeing to. Like all construction lenders, those stepping in at mid-construction should consider the strength of the borrower and guarantors, and obtain (or succeed to) completion guarantees. Because there are additional risks inherent in a mid-construction scenario, including claims that are allegedly attributable to the acts or omissions of the exiting lender, a new lender should also consider requesting protection from the guarantors with regard to these incremental lender risks arising from acts or omissions prior to the date of refinancing.

The new lender will likely require an assignment of all documents from the exiting lender, and the exiting lender should not object, provided that the assignments are nonrecourse (or limit recourse to the assigning lender to a very short list of matters). Notwithstanding the assignment, it is advisable for the new lender to require a new Notice of Lending. If for no other reason, a new Notice of Lending is prudent to obtain because the County Clerk may refuse to accept an assignment of Notice of Lending, and the statute does not provide sufficient comfort that a successor lender will be protected by an assigned Notice of Lending.


There are many reasons a lender may want to take over a construction loan. Perhaps the lender sees the loan as an opportunity to establish or strengthen a relationship with a developer client. Or maybe the lender has an opportunity to make a "mini-perm" loan that will enable it to capture the post-completion financing that it would otherwise lose to competitors.

Whatever the reason, it is clear that refinancing a building loan during construction raises unique and potentially costly risks for a lender. By careful due diligence and proper documentation, however, a replacement lender may get sufficiently comfortable that the shoes it is stepping into can be made to fit as comfortably as possible.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.