Can your lender stop funding mid construction? The short answer is yes, which can be disastrous for all concerned. 

A key consideration is that once the project has commenced the lender, just like the developer, is relying on the successful completion of the project to get their money back. All lenders advance construction funds against a certified cost expended value adjusted for the cost to complete.

The project needs to be completed and sold or refinanced in order for the debt to be repaid and a profit realised. It is unlikely therefore, that half way through the project with half the debt advanced (and all the developer’s equity), that a sale could actually be achieved, let alone at a price that would recover the lender's exposure. 

In this situation, a lender would be more inclined to appoint receivers and managers to secure the completion of the project and avoid or minimise any potential loss. The additional costs associated with this process will however, in most cases, wipe out the projected profit along with all or a good portion of the developer’s equity.

So why then would a lender choose to stop funding mid construction and expose itself to this probable outcome. Circumstances which could result in this situation include:

1. Concerns regarding the builder’s ability to complete the project due to a deteriorating financial position or unresolved issues with sub-contractors and or unions. 
2. Identification of cost overruns or variations, which make the project financially unviable.
3. A breach of covenants, event of default or a “Material Adverse Change” as specified in the loan documents, which in the lender's view will have a material detrimental financial impact on the financial viability of the project.

So, how do you protect yourself from these circumstances occurring?

1. Firstly, it’s imperative that you undertake rigorous due diligence prior to appointing a builder to ensure there is minimal risk of their failure. A tender process is strongly recommended and you should seek advice from your experienced quantity surveyor who will usually be aware of any concerns about individual builders. The financier will likely engage and instruct its own quantity surveyor and again, experience shows that there is usually good market 'intel' around well before a builder’s failure, so don’t ignore the warning signals.
2. You should also ensure that you have access to enough capital reserves or a cashflow that will allow you to meet any potential cost overruns. This will ensure the lender remains comfortable that its risk position will not be compromised and make them more likely to allow progressive use of retention funds for small variations.
3. Be sure that you understand all of the covenants and undertakings that you are signing up to as well as what constitutes an event of default. These are always clearly detailed and you should take time to read, understand and if required obtain legal advice before you sign off. If an event occurs that is likely to cause a breach then you should proactively engage with the lender to make them aware of the situation and your proposed strategy to remedy it. 
4. A material adverse change is likely to be something that is completely out of your control. The best course of action in this instance is to be co-operative and collaborative in an open and frank manner; clearly spelling out to the lender what you can and cant do to address the situation.

In summary, your lenders best interests are best served by the project being completed and sold or refinanced, however if something goes wrong, be it within or outside of your control, the lender will not hesitate to act in the best interests of its shareholders or investors. 

So the smart developer protects their own position by working with their lender to find a satisfactory solution that ensures the best possible economic outcome.

This is a sponsored article.

This article was written by Dan Holden of HoldenCAPITAL, a bespoke construction finance firm. HoldenCAPITAL arranges construction finance and invests in projects through their equity trust, HoldenINVEST. To discuss your project finance requirements please call (07) 3171 4200 or visit www.holdencapital.com.au.

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