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Construction Law SeminarFor Lenders in Troubled Times
Construction Law Seminar
DLA Piper – Washington, DC
February 19, 2009
BEING PREPARED FOR CONSTRUCTION CLAIMS AND ISSUES:IDENTIFYING AND UNDERSTANDING KEY ISSUES
Brian K. FieldenAnthony L. Meagher
February 19, 2009Construction Law Seminar
Identifying and Understanding Key Issues
Key provisions in design contracts
Key provisions in construction contracts
February 19, 2009Construction Law Seminar
Standard Industry Forms – Design & Construction Contracts
American Institute of Architects (AIA)
Design Build Institute (DBIA)
Engineers’ Joint Contract Documents Committee (EJCDC)
February 19, 2009Construction Law Seminar
Key Provisions in Design Contracts
February 19, 2009Construction Law Seminar
Avoid Waiver of Consequential Damages Provisions
Found in most form documents; e.g., 2007 AIA B101 § 8.1.3
This waiver is broad enough to encompass all damages of the owner except direct costs of correcting defective design
Problem: may preclude owner from recovering damages incurred by contractor due to defective design
February 19, 2009Construction Law Seminar
Owner
Architect
Design-BuildContractor
Subcontractors
Owner
Architect Contractor
Subcontractors
Negligence Spearin
Avoid Waiver of Consequential Damages Provisions
Traditional Design-Build
February 19, 2009Construction Law Seminar
Avoid Waiver of Consequential Damages Provisions
Spearin Doctrine: owner held liable to contractor for contractor’s direct costs and damages due to defective design
However, …. contractor’s damages (which are recoverable from owner under spearin doctrine) would be purely “consequential” damages from standpoint of architect
Thus, owner held liable to contractor for damages due to architect’s negligent design, but …..
Owner has no claim back against architect due to “Waiver of Consequential Damages” provision
February 19, 2009Construction Law Seminar
Avoid Limitation of Liability Provisions
Usually tied to designer’s fee or some low amount (e.g., $25,000)
Danger: do not utilize signed proposals as the agreement or incorporate proposals into final agreement
Do not tie liability limitation to proceeds received from insurance
February 19, 2009Construction Law Seminar
Delete Non-Joinder Clause
AIA non-joinder clause 1997 AIA B141 § 1.3.5.4 – “No arbitration arising out of this Agreement shall include . . . an additional person or entity not a party to this Agreement.”
1997 AIA A201 § 4.6.4 – “No arbitration arising out of this Agreement shall include . . . the Architect.”
Potential for conflicting results!
2007 AIA Documents have changed this result
February 19, 2009Construction Law Seminar
Non-Joinder Clauses in 2007 AIADocuments
Now either party may consolidate the arbitration with any other arbitration to which it is a party (e.g. Owner could consolidateOwner/Contractor arbitration w/ Owner/Architect arbitration) if (1) the arbitration agreement governing the other arbitration permits consolidation, (2) the arbitrations involve common questions of law or fact and (3) the arbitrations employ materially similar procedural rules and methods for selecting arbitrator(s). (A201 15.4.4.1; B101 8.3.4.1)
May join other parties on the same grounds as 1997 version, but only with their consent (A201 15.4.4.2; B101 8.3.4.2)
Thus, consistency in dispute resolution clauses in the various contracts and subcontracts is more important than ever
February 19, 2009Construction Law Seminar
Ownership of Drawings Provision
Ownership of drawings and specifications provisions are heavily negotiated
Key issue for lenders: ownership of drawings upon terminationAIA: “instruments of service” with revocable license; owner looses license when contract is terminated
Incremental transfer upon payment
February 19, 2009Construction Law Seminar
Ownership of Drawings Provision
Architect acknowledges and agrees that all right, title, and interest under federal and state copyright and intellectual property laws in any design documents, reports, data, or design concepts, CADD materials, models and information produced by Architect or anyone working under Architect in connection with this Agreement, including but not limited to, any Architectural Works of the Project as defined by the federal Architectural Works Copyright Act (including those furnished in electronic form) shall be conveyed, assigned and transferred by the Architect to the Owner upon submittal of such documents to the Owner and payment by the Owner for the Services required to produce those documents. Architect and its Consultants shall not place a copyright notation on such documents. The rights vested in Owner pursuant to this Article shall not be construed so as to preclude Architect from utilizing standard report language or individual standard features on other projects for other clients. Otherwise, the Architect may not use the design documents on other projects. Owner may furnish documents, reports or other data produced by Architect to third parties in connection with completing the projects contemplated by Owner, and such third parties may rely on such documents, reports and data. Reuse or modification of the aforementioned documents by the Owner without the Architect’s written permission shall be at the Owner’s risk, and the Architect shall have no liability with respect to such reuse or modification.
February 19, 2009Construction Law Seminar
Key Provisions in Construction Contracts
February 19, 2009Construction Law Seminar
Scope of Work
Coordinating the contract documentsContractor proposals incorporated by reference often conflict with contract terms or contain outdated pricing / scope information
Reference drawings & specifications issued for construction
Exclusions and qualificationsReview business and legal terms
February 19, 2009Construction Law Seminar
Completion Dates
Specific, enforceable dates
Define the dateWhat work must be completed by when?
Definition will vary by project type
Consequences of not meeting datesLiquidated damages
Opt for actual damages, instead of liquidated damages
February 19, 2009Construction Law Seminar
Delays and Delay Damages
Time ExtensionsSpecifically define when extensions are allowed
Outside of contractor’s control / “critical path activities of the work”
Delay DamagesSubcontractor costs & jobsite overhead only
Never agree to home office overhead
Waiver of Consequential DamagesMore favorable to contractor than owner
Consider carveouts (delay, insurable claims, damages arising out of defective work, intentional misconduct, etc.)
February 19, 2009Construction Law Seminar
Limited Delay Damages Clause
In the event of delay, interference, disruption or inefficiency in the work caused by the Owner, the Architect or any of their consultants or employees, or in the event the Contractor claims that its operations were accelerated, resequenced, impacted, or made less efficient or more expensive, the Contractor shall be entitled to an equitable extension of the Contract Time to coverdelays in the critical path activities of the Work, and shall beentitled to recover compensation or damages only for actual increases in cost for project site personnel, project site equipment, project site labor and other miscellaneous expenses at the project site caused by the delay. In no event shall Contractor be entitled to other general conditions costs, home office overhead, lost profits, loss of use of capital or any other type of consequential damages.
February 19, 2009Construction Law Seminar
Notice Provisions
Notice provisions should be consistent
Contractor should provide written notice of any claim for extra time or extra compensation
2007 AIA A201 provides for up to 21 days’ notice
10-14 days is adequate
Owner must make informed decisions
Early claims resolution
Claim is waived if notice not provided
February 19, 2009Construction Law Seminar
Notice Provision
If the Contractor believes it is entitled to an increase in the Contract Sum, or an extension of the Contract Time, or believes it has any other claim for monetary compensation, damages or time extensions from the Owner, the Contractor shall give the Owner written notice of such claim within ten (10) days after the occurrence giving rise to such claim. The notice required by this Paragraph is a condition precedent to the assertion of any claim by the Contractor. If the Contractor fails to give the Owner timely written notice of a claim, as required by this paragraph, the contractor will be deemed to have waived the claim, and the Owner shall have no further liability respecting the claim. . .
February 19, 2009Construction Law Seminar
Indemnity
Indemnity Related to Insurable Claims (Injuries to Persons / Property)Standard industry forms contain indemnity for personal injury and property damage, “but only to the extent caused by” the contractor (e.g., 2007 AIA A201)
Excludes claims resulting from joint negligence of owner or architectOwner’s insurance must get involved for claims not solely the fault of contractor
Consider obtaining “in whole or in part” indemnity (may be invalid in some states)Indemnity for claims caused by sole negligence are invalid in most states
February 19, 2009Construction Law Seminar
Standard Indemnity Language (Related to Insurable Claims)
The Contractor shall indemnify, hold harmless, and defend the Owner, its lender the Owner's project manager (if any), Architect and all of their agents, employees, consultants, parent subsidiaries or affiliated companies, successors and assigns from and against claims, damages, losses and expenses (including, but not limited to, attorneys' fees) arising out of or resulting from performance of the Work, but only to the extent such claims involve injuries to persons and/or property and arecaused in whole or in part by negligent acts or omissions of theContractor, a Subcontractor, a Sub-Subcontractor, a material or equipment supplier, or anyone directly or indirectly employed bythem or anyone for whose acts they may be liable, regardless of whether such claim, damage, loss or expense is caused in part by a party indemnified hereunder.
February 19, 2009Construction Law Seminar
Indemnity
Indemnity Related to Insurable Claims (Injuries to Persons/Property)
Indemnity Related to Performance
February 19, 2009Construction Law Seminar
Standard Indemnity Language (Related to Performance)
The Contractor hereby agrees to defend, indemnify and hold the Owner and its lender harmless from any and all claims, suits, liens, demands, debts, damages, loss or expense, including, but not limited to, attorney’s fees and litigation expenses, suffered or incurred by the Owner as a result of the Contractor’s failure to perform in accordance with the Contract Documents.
February 19, 2009Construction Law Seminar
Protection Against Liens
Take advantage of statutory tools to eliminate / minimize lien exposure at the outset
Notice of commencementFiled at beginning of project
Benefit varies from state-to-state
Contract provisions should mandate compliance
February 19, 2009Construction Law Seminar
Lien and Claims Waivers
Lien waivers on owner’s form – attached as exhibits
Statutory form lien waivers
Lien waiver + claim waiver – “bring the project current”approach
February 19, 2009Construction Law Seminar
Lien and Claim Waivers
Lien waiver + claim waiver – if permitted by state statute, include additional waivers and representations
All lower tier subcontractors and suppliers have been paid in full and there are no outstanding claims
Payment = payment in full for all work and costs to date
Waive all claims for damages due to delay, hindrance, interference, acceleration, inefficiencies, extra work, or any other claims through the date of the waiver
Eliminate claims through the payment process
February 19, 2009Construction Law Seminar
Termination Clause - For Convenience
The Owner may terminate the Contract for convenience at any time upon written notice to the Contractor. In the event of a termination for convenience, the Contractor shall take immediate steps to terminate the Work as quickly and effectively as possible and shall terminate all communications to third parties unless otherwise instructed by the Owner. Provided that no damages are due to the Owner for Contractor’s failure to perform in accordance with the Contract, the Owner shall pay the Contractor for all Work performed to the date of termination, including reasonable overhead and profit for that portion of the Work, and for any other expenses incurred by the Contractor in terminating its activity at the Project site, and the Owner shall have no further liability to the Contractor for such termination.
February 19, 2009Construction Law Seminar
Termination Clause – For Cause
The Owner may terminate the contract for cause if the Contractor breaches any material provision of the Contract Documents. The Owner shall give the Contractor seven (7) days written notice of its intent to terminate the Contract, and, if the Contractor fails to cure the default within that period, the termination shall take place without further notice. In the event of a termination for cause, the Contractor shall not be entitledto further payment until the Work is completed by others. If the cost of completing the Work, combined with previous payments to the Contractor, is less than the Contract Price, theContractor shall be paid the difference. If the cost of completing the Work, combined with previous payments to the Contractor, exceeds the Contract Price, the Contractor shall pay the difference to the Owner.
February 19, 2009Construction Law Seminar
Termination Clause
If the Owner terminates the Contract for cause, and it is later determined that the Owner did not have grounds to do so, the termination will be treated as a termination for convenience under the terms of this Paragraph.
February 19, 2009Construction Law Seminar
Owner’s Disclosure of Financial Information
Previously A201 permitted the Contractor significant, seemingly unfettered, rights to require disclosure of the Owner’s confidential financial arrangements relating to the ProjectContractor could refuse to start or continue the Work absent satisfactory informationPotentially led to harassment, distraction and discord between the Owner and Contractor2007 version (§ 2.2.1) is an improvement for Owners, now essentially permitting the Contractor just one look prior to commencing the work Cause required thereafter:
Owner fails to make payments to the Contractor as the Contract Documents requireA change in the Work materially changes the Contract SumContractor identifies in writing a reasonable concern about the Owner’s ability to make a payment when due
Construction Law SeminarFor Lenders in Troubled Times
Construction Law Seminar
DLA Piper – Washington, DC
February 19, 2009
The Morning After: Handling Borrower and Contractor Default
Robert L. CrewdsonScott Weinberg
February 19, 2009Construction Law Seminar
II. ASSESSING PROJECT STATUS AND LIABILITIES
Pre-Workout Loan Document ReviewLoan Status1. Payment/Maturity Default2. Status of Covenant Compliance
Critical Date Status (i.e. deadlines for marketing property, maintaining entitlements, or delivering property to tenants or unit purchasers)
1. Review loan balancing tests and make demands on borrower to makecash deposits necessary to bring loan into balance
2. Confirm Borrower and guarantor financial reporting compliance
February 19, 2009Construction Law Seminar
II. ASSESSING PROJECT STATUS AND LIABILITIES
Pre-Workout Loan Document ReviewOther Documents and Concerns
Review loan guaranties and assess guarantor’s ability to perform guaranteed obligationsConfirm status of property entitlements, including any condominium offering plansCompile all borrower notices and related loan noticesAssess the status of loan participations and/or intercreditoragreements that may effect exercise of remedies; deliver any required copies of notices and obtain needed consents from participants and/or junior lenders
February 19, 2009Construction Law Seminar
II. ASSESSING PROJECT STATUS AND LIABILITIES
Pre-Workout Loan Document ReviewOther Documents and Concerns
Review any takeout loan commitment, give any required notices and/or obtain needed consents Have Borrower and Guarantors sign a “Pre-Workout” LetterObtain updated title searchConsider obtaining updated environmental report
February 19, 2009Construction Law Seminar
II. ASSESSING PROJECT STATUS AND LIABILITIES
Pre-Workout Loan Document ReviewAssess Viability of Development Plan
Is the project as structured still legally viable (e.g., should condo project be changed to rental?)Even though it will produce a certain loss, should lender simply walk away? Consider obtaining updated appraisal and market survey
February 19, 2009Construction Law Seminar
II. ASSESSING PROJECT STATUS AND LIABILITIES
Pre-Workout Loan Document ReviewConsiderations on whether or not to pursue foreclosure
Why did loan go into default? Borrower issue or market issue? Is the Borrower honest and cooperative? Are they exerting maximum effort? Are they stretched too thin on other projects? Costs of foreclosure (e.g., legal fees, transfer taxes)Are there parts of the property which are operational and generating cash? Should a receiver be sought?
February 19, 2009Construction Law Seminar
II. ASSESSING PROJECT STATUS AND LIABILITIES
Pre-Workout Loan Document ReviewConsiderations on whether or not to pursue foreclosure
Effect of delay in project caused by foreclosure (will work continue during pendency of action) Is Borrower willing to give a deed in lieu of foreclosure?Assess whether foreclosure filing will precipitate Borrower or Guarantor bankruptcy filing Does property have any environmental issues? Are there any PR or reputational constraints on foreclosure?
February 19, 2009Construction Law Seminar
II. ASSESSING PROJECT STATUS AND LIABILITIES
Project Cost and Construction Contract Exposure Sworn Statements/Bring Project Current
Analysis of Pending Construction Claims
a. Technical Analysis
b. Legal Analysis
Analysis of Potential Construction Claims
a. Technical Analysis
b. Legal Analysis
February 19, 2009Construction Law Seminar
II. ASSESSING PROJECT STATUS AND LIABILITIES
Assessing Quality of the Work/Defect Issues Technical AnalysisSpecial Attention to “Killer Issues”
February 19, 2009Construction Law Seminar
III. ASSUMPTION OF CONTRACTS
Contracts Available By Assignment
Assumption/Assignment LimitationsPayment of Existing Liabilities/Amounts Due
Other Restrictions/Limitations
Documenting Takeover/Ongoing Contractual Relationship with Project Parties
Notice Letter
Acknowledgment of Assignment
February 19, 2009Construction Law Seminar
III. ASSUMPTION OF CONTRACTS
Guaranties and Surety BondsNamed or Additional Obligee
Possible Defenses to Continuing Obligation of Surety or Guarantor
Limitations of Liability/Coverage
February 19, 2009Construction Law Seminar
IV. MANAGING THE PROJECTAS OWNER
Project ManagementFirmsScope of Authority Issues
Quality Control Issues/Special RisksImmediate ReviewOngoing Verification
Claim Analysis/ManagementInsurance Coverage Analysis
Transition IssuesCoverage in Place
February 19, 2009Construction Law Seminar
V. CONTRACTOR DEFAULT
Termination Remedies/Completion Options
GuarantiesDischarge Issues
Limitations on Remedies
Surety BondsDischarge Issues
Limitation on Remedies
Managing Lien/Payment Issues
February 19, 2009Construction Law Seminar
V. CONTRACTOR DEFAULT
Managing Subcontractor Assignments
Managing Defective Work Issues
Contractual Defenses and Limitations of Liability
Construction Law SeminarFor Lenders in Troubled Times
Construction Law Seminar
DLA Piper – Washington, DC
February 19, 2009
Understanding The Essential Elements of Performance and Payment Bonds
Robert L. Crewdson
February 19, 2009Construction Law Seminar
Performance Bonds
Surety Obligation to PerformNOW, THEREFORE, the conditions of this obligation are as follows, that if the Principal shall fully and completely perform all the undertakings, covenants, terms, conditions, warranties, and guarantees contained in the Construction Contract, including all modifications, amendments, changes, deletions, additions, and alterations thereto that may hereafter be made, then this obligation shall be void; otherwise it shall remain in full force and effect.
February 19, 2009Construction Law Seminar
Performance Bonds
Completion OptionsComplete the Construction Contract in accordance with its terms and conditions; or
Obtain a bid or bids for completing the Construction Contract inaccordance with its terms and conditions, and …, arrange for a contract between [the low] bidder and Owner …; or
If the Surety does not promptly perform under (1) or (2) above, allow the Owner to complete …
February 19, 2009Construction Law Seminar
Performance Bonds
Notice to the SuretyComplete commence performance of its obligations and undertakings under this Bond promptly and without delay, after written notice from the Owner to the Surety.
February 19, 2009Construction Law Seminar
Performance Bonds
Waiver of Notice ClauseThe Surety hereby waives notice of any and all modifications, omissions, additions, changes, alterations, extensions of time, changes in payment terms, and any other amendments in or about the Construction Contract, and agrees that the obligations undertaken by this Bond shall not be impaired in any manner by reason of any such modifications, omissions, additions, changes, alterations, extensions of time, change in payment terms, and amendments.
February 19, 2009Construction Law Seminar
Performance Bonds
Indemnification ClauseIn addition to performing as required in the above paragraphs, the Surety shall indemnify and hold harmless the Owner from any and all losses, liability and damages, claims, judgments, liens, costs and fees of every description, including reasonable attorney’s fees, litigation costs and expert witness fees, which the Owner may incur, sustain or suffer by reason of the failure or default on the part of the Principal …
February 19, 2009Construction Law Seminar
Performance Bonds
No Statute of Limitations
February 19, 2009Construction Law Seminar
What is a Payment Bond?
February 19, 2009Construction Law Seminar
Payment Bonds
Obligation to Bond Off LiensIn the event a Claimant files a lien against the property of theOwner, and the Principal fails or refuses to satisfy or remove it promptly, the Surety shall satisfy or remove the lien promptly upon written notice from the Owner, either by bond or as otherwise provided in the Construction Contract.
February 19, 2009Construction Law Seminar
Payment Bonds
Definition of ClaimantsA “Claimant” shall be defined herein as any subcontractor, person, party, partnership, corporation or other entity furnishing labor, services or materials used, or reasonably required for use, in the performance of the Construction Contract, without regard to whether such labor, services or materials were sold, leased or rented, and without regard to whether such Claimant is or is not in privity of contract with the Principal or any subcontractor . . .
February 19, 2009Construction Law Seminar
Payment Bonds
Notice Periods for Claimants
February 19, 2009Construction Law Seminar
General Considerations
1. Dual Obligee Riders
2. Single Payment and Performance Bond v. Separate Bonds
3. Subcontractor Bonds as Substitute for Contractor Bonds
February 19, 2009Construction Law Seminar
Surety Discharge Issues
Changes in Contract
Steven W. SachsSenior Vice President and Director
National Real Estate and Hotel Practice
Before Disaster Strikes –Construction Insurance in Troubled Times
February 19, 2009Construction Law Seminar
Objectives
Provide practical information that allows you to place insurance“terminology” within a business context
Establish framework for a better understanding of insurance sections of construction documents
February 19, 2009Construction Law Seminar
Objectives
Identify critical due diligence issues for REO and/or DistressedDevelopment/Construction loans.
Provide a basis for the formation of relationships between owner’s project managers, attorneys, risk managers, insurance consultants, or knowledgeable insurance brokers
February 19, 2009Construction Law Seminar
How do I determine what insurance to require or purchase?
Make it Part of a Business Process that:
Identifies risk of loss to assets and/or revenue stream
Measures and evaluates both probability of loss and financial impact
Reviews Risk Techniques (avoidance, assumption, retention, transfer, risk control and prevention)
February 19, 2009Construction Law Seminar
We Are All Risk Managers
Identify what can happen and where you want to be after event or situation occurs
Language is drafted to place the company in preferred position
Ability is based on:
Fairness of issue
Economic leverage
Understanding Contractor’s issues/concerns
February 19, 2009Construction Law Seminar
Types of Construction orDevelopment Insurance Coverage
February 19, 2009Construction Law Seminar
Builders Risk
Named Perils versus Causes of Loss –
Special Form (aka All Risk)
Earthquake
Flood
Windstorm
Subsidence/Sink Hole
Transit
Off-Site Coverage
Renovation Projects – coverage under existing property policy versus builders risk
February 19, 2009Construction Law Seminar
Builders Risk (continued)
Soft Costs
Business Interruption
Permission to Occupy
Boiler and Machinery (energy coverage)
Testing Exclusion
Waiver of Subrogation or Recovery
Terrorism Coverage
Purchased by Owner or General Contractor
February 19, 2009Construction Law Seminar
Commercial General LiabilityCoverage (Contractor’s)
Contractor Operations
Independent Contractors
Contractual Liability (indemnity and hold harmless agreements)
Conform with Local Statutes
Products/Completed Operations (Construction Defects)
Contractor’s Pollution Liability
February 19, 2009Construction Law Seminar
Additional Insured vs. Insured or Owners and Contractors Protective Liability Coverage
Primary, Non-Contributory and Not Excess
Specify “Additional Insured Form” to be used
Use Form CG 20 26 11 85 or 20 10 11 85
Resist CG 20 10 10 93
Need for Owner to carry its own CGL Coverage even if a contractor adds owner as additional insured or provides Owners and Contractors Protective Policy
February 19, 2009Construction Law Seminar
Umbrella Liability or Excess Coverage
What Limit is Correct?
February 19, 2009Construction Law Seminar
Professional Liability Coverage
Architects and Engineers
Limits
Practice Policies versus Project Policies
Indemnity Issues
Claims Made Forms – require that coverage be maintained 2-5 years past completion
February 19, 2009Construction Law Seminar
Pollution Liability Coverage (Owner)
Clean Up (on and off-site)
Third Part Liability (on and off-site)
Diminution of Value
Business Interruption
Cost Cap Coverage
It can make a transaction happen
Mold Issues
February 19, 2009Construction Law Seminar
Owner Controlled or Directed InsuranceProgram
If you have a Wrap Up in place, it has its own considerations
February 19, 2009Construction Law Seminar
Other Issues – Construction Defects
Condominium Risk Management Issues:
Breach of Fiduciary Duty
Nondisclosure
Negligent Conversion
Statute Violation
February 19, 2009Construction Law Seminar
Other Issues – Construction Defects
A Brave New World
Statutes of Limitations
Statutes of Repose
February 19, 2009Construction Law Seminar
Other Issues – Construction Defects
Where’s The Beef?
A lack of uniformity in interpreting the Commercial General Liability (CGL) policy’s scope of coverage for construction defect claims has made the determination of coverage challenging for even the most straight forward claim
February 19, 2009Construction Law Seminar
Other Issues – Construction Defects
Insurance Voodoo
Read the policy and endorsements carefully
Many insurers are adding endorsements that limit coverage for residential contractors and developers
Read the policy, not the “certificate of insurance”
February 19, 2009Construction Law Seminar
Other Issues – Construction Defects
What are the basics?
Think more like a homebuilder than a typical commercial developer
Inspection/Documentation/Communication
Problem Resolution
February 19, 2009Construction Law Seminar
Critical Review Issues for Troubled Loans
Detailed Review of Existing Insurance Program surrounding the construction/development project:
General Liability (including completed operations)*
Workers Compensation*
Excess Liability (Umbrella)*
* - may be accomplished via a wrap up or traditionally where all contractors provide their own insurance per contractual requirements
February 19, 2009Construction Law Seminar
Critical Review Issues for Troubled Loans (continued)
Detailed Review of Existing Insurance Program surrounding the construction/development project:Builders Risk – Breadth of coverage (Soft Cost and Business Interruption)Environmental Liability*Professional LiabilityOwner/Developer’s Protective Liability Policy* - may be accomplished via a wrap up or traditionally where all contractors provide their own insurance per contractual requirements
February 19, 2009Construction Law Seminar
Critical Review Issues for Troubled Loans (continued)
If the General Contractor (GC) procured the insurance and entity remains on the project performing his contractual obligations, the new Owner/Lender should seek to be included on the policies as the First Named Insured.
If the Borrower (owner/developer/general contractor) procured the insurance and is no longer in business or unable to complete this particular project, the Lender should explore the option of continuing the existing insurance program.
February 19, 2009Construction Law Seminar
Critical Review Issues for Troubled Loans (continued)
Any project specific insurance already in place should be reviewed and determined if insurance coverage/limits are appropriate, and if possible transferable to the new interests.
February 19, 2009Construction Law Seminar
Critical Review Issues for Troubled Loans (continued)
Liability issues:Review the contractual liability between the borrower/new interests and general contractor
Does insurance meet contractual requirements?
Review financial solvency of the general contractor and sub-contractors – surety or sub-contractor caution
Possible safety cutbacks from on-site contractors
February 19, 2009Construction Law Seminar
Critical Review Issues for Troubled Loans (continued)
Liability issues:Potential increase in workers compensation and third party over claims due to drop in employmentConstruction defect claims and completed operations coverage gaps
Contractors Pollution Liability
Professional Liability Issues
February 19, 2009Construction Law Seminar
Conclusion:
Projects are being delayed, cancelled and ownership changes are definitely increasing in today’s financial and legal climate.
Choose Competent Business Partners
Attorneys
Accountants
Construction Consultants
Insurance Advisors/Brokers
Construction Law SeminarFor Lenders in Troubled Times
Construction Law Seminar
DLA Piper – Washington, DC
February 19, 2009
Bankruptcy and Construction:Practical Tips for Survival
C. Kevin Kobbe
Dennis J. Powers
February 19, 2009Construction Law Seminar
Introduction
In 2008, 143 homebuilders filed for bankruptcyAs compared to 80 in 2007 (and less in prior years)Some builders reorganized, but most liquidated
According to a recent report issued by a major accounting firm, approximately 30% of homebuilders are in financial distress
This includes some major industry players2009 is expected to bring record numbers of bankruptcy filings in the industryIn addition, many small builders will simply cease operations without the formality of a bankruptcy filing
February 19, 2009Construction Law Seminar
Brief Overview of Bankruptcy
Provide the debtor with a “fresh start”To provide a framework for orderly liquidation or orderly reorganization of a debtor (as applicable)To facilitate the fresh start, the Bankruptcy Code employs two significant concepts:
Automatic stayDischarge of debts
For lenders, bankruptcy frequently means:DelayExpenseAggravation
Purpose of Bankruptcy Code
February 19, 2009Construction Law Seminar
Brief Overview of Bankruptcy
Bankruptcy Court is adjunct of U.S. District CourtBankruptcy Judges serve 14-year terms (no lifetime appointments)Bankruptcy Courts have limited jurisdiction
Matters arising under the Bankruptcy CodeMatters related to a bankruptcy case
Venue Location of debtor’s domicile, residence, principal place of business or principal assets for 180 daysAffiliate rule
Bankruptcy Court Jurisdiction and Venue
February 19, 2009Construction Law Seminar
Brief Overview of Bankruptcy
Chapter 7Available for both individuals and businesses
Appointment of Trustee
Chapter 11Also available for both individuals and businesses, but primarily used for business reorganization
Debtor in Possession
Chapter 13 Available only to individuals
Repayment plan administered by standing Trustee
Availability of Chapters 7, 11 and 13
February 19, 2009Construction Law Seminar
Brief Overview of Bankruptcy
Bankruptcy Code (11 U.S.C. § 101, et seq.)
Federal Rules of Bankruptcy Procedure
Federal Rules of Civil Procedure
Federal Rules of Evidence
Local Rules
Federal Statutes governing bankruptcy-related matters (e.g., jurisdiction, venue, appeals)
www.uscourts.gov/bankruptcycourts
www.abiworld.org
Sources of Bankruptcy Law
February 19, 2009Construction Law Seminar
How Bankruptcy Changes the Landscape
Immediately triggered by bankruptcy filingProtects both the Debtor and the Debtor’s PropertyGenerally all enforcement activities in which creditors traditionally engage are stayedApplies in both voluntary and involuntary casesEffective Immediately without any court actionEffective against All Creditors regardless of Notice
Dual Purpose:Protection from Creditors (a “breathing spell” for the Debtor)Prevents individual creditors from taking advantage of the Debtor; promotes the bankruptcy goal of equality of distribution
1. The Automatic Stay
February 19, 2009Construction Law Seminar
How Bankruptcy Changes the Landscape
The Bankruptcy Code includes numerous exceptions to the automatic stay, including action to perfect, or to continue perfection of, a mechanic’s lien Special Rules for Single Asset Real Estate Debtors
A single asset real estate case generally involves a debtor with no substantial business other than operation of a single real estate project other than residential real property with fewer than 4 unitsIn general, a secured creditor is entitled to relief from stay unless a single asset real estate debtor, within 90 days after commencement of the case, either:(a) Files a plan with a reasonable possibility of confirmation; or(b) Commences monthly payments to the secured creditor
1. The Automatic Stay (cont’d)
February 19, 2009Construction Law Seminar
How Bankruptcy Changes the Landscape
Mandatory Disclosures by DebtorSchedules of Assets and LiabilitiesStatement of Financial AffairsMonthly Operating Reports (Chapter 11)Disclosure Statement (Chapter 11)
Meeting of CreditorsTraditional Discovery Devices Available in Adversary Proceedingsand Contested MattersFRBP 2004
Available absent pending Adversary Proceeding or Contested MatterPermits broad examination of “any entity”
2. Disclosure of Financial Information
February 19, 2009Construction Law Seminar
How Bankruptcy Changes the Landscape
Debtor retains control over assets and financial affairs
Under limited circumstances, however, management may be ousted
Salaries of officers subject to review
DIP is a fiduciary
3. The Chapter 11 Debtor in Possession Concept
February 19, 2009Construction Law Seminar
How Bankruptcy Changes the Landscape
Broad definition of property of the estate
Bankruptcy Court has broad jurisdiction
Single forum for dispute resolution on any issue relating to debtor’s financial affairs
Elimination of collateral litigation
4. Single Forum
February 19, 2009Construction Law Seminar
How Bankruptcy Changes the Landscape
Debtor’s ability to use, sell or lease property is restricted to “ordinary course of business” transactions
Debtor may not incur new debt without court approval
Lender under no obligation to extend additional credit
Restrictions on use of “cash collateral”
Settlements must be approved by Bankruptcy Court
5. Restrictions on Debtor’s Activities
February 19, 2009Construction Law Seminar
How Bankruptcy Changes the Landscape
Unsecured creditors and beyond
Unsecured creditors should consider pros and cons of committee service
Watchdog function; heightened scrutiny of actions taken by the debtor and the secured creditors
Lenders are frequently the target of committee investigation
Another seat at the table; another hog at the trough
6. Appointment of Committees in Chapter 11 Cases
February 19, 2009Construction Law Seminar
How Bankruptcy Changes the Landscape
Bankruptcy Court has authority to approve sale free and clear ofliens, claims, encumbrances and other interests
Some Advantages of Bankruptcy Sales:Bankruptcy Court order provides finality of sale and additional protection for purchaser
Integrity of process; purchasers have confidence
Assets may be sold free and clear, even if purchase price is less than liens (lenders beware)
Tax advantages is sale if conducted under terms of a plan
7. Sale of Assets
February 19, 2009Construction Law Seminar
How Bankruptcy Changes the Landscape
Subject to Bankruptcy Court approval, a debtor may assume or reject
Right to reject burdensome leases is a key benefit to many debtors (e.g., retail bankruptcies)
8. Executory Contracts and Unexpired Leases
February 19, 2009Construction Law Seminar
How Bankruptcy Changes the Landscape
Bankruptcy Code provides for various causes of action (e.g., preferential transfers and fraudulent transfers)
Potential claims against lenders are typically investigated
Increased scrutiny = increased risk
9. Bankruptcy Causes of Action
February 19, 2009Construction Law Seminar
How Bankruptcy Changes the Landscape
Ultimate goal of a Chapter 11 case is plan confirmation
A plan is essentially an agreement between the debtor and its creditors to restructure obligations
Plans are frequently designed to impair the interests of lenders
In general, the debtor has exclusive right to file a plan for 120 days (180 days in a small business case)
10. Chapter 11 Plan of Reorganization
February 19, 2009Construction Law Seminar
Bankruptcy and Construction:Practical Tips for Survival
When the owner or contractor is on the brink of bankruptcy.
Mechanics lien claims in bankruptcy.
Terminating the contractor in the bankruptcy context.
February 19, 2009Construction Law Seminar
When the Contractor is on the Brink
Important that lender become proactive.
Ensure change orders up to date (especially deductive).Trustee will pursue owner for monies due contractor.
Be vigilant about sworn statements and subcontractors’waivers.
Unpaid subcontractors may have lien rights that prime the lender’s rights.
If possible, eliminate trailing waivers.
Joint checks to contractor and subcontractors.
February 19, 2009Construction Law Seminar
When the Contractor is on the Brink
Performance and Payment Bonds.
Ensure bonds are in place.If the lender is a joint obligee, lender will have rights under the bond.
Review and verify bonds are properly issued.
February 19, 2009Construction Law Seminar
When the Owner is on the Brink
Exercise rights under the loan documents before bankruptcy is filed.
Declare an event of default if cause exists.
Appoint a receiver.Can then request bankruptcy court to keep your receiver in place.
Verify status of project with contractor.Current contract pricePayment status
February 19, 2009Construction Law Seminar
When the Owner is on the Brink
Payments to contractors may not be vulnerable to a preference action.
The contractor is viewed as a secured creditor.
Even if the lien is not yet perfected.
February 19, 2009Construction Law Seminar
When the Owner is on the Brink
GuaranteesBad boy guaranty
Blue Hills Office Park LLC v. J.P. Morgan Chase Bank, 477 F. Supp. 2d 366 (D. Mass.).
Completion guarantyMay require guarantors to pay contractors and keep property lien free.Construed by the courts as a security interest. Guarantor often not required to complete improvements if lender fully secured.If lenders forecloses and sells property, it may lose the benefits of completion requirement.
February 19, 2009Construction Law Seminar
Lien Claims in Bankruptcy
Contractors may perfect their lien rights after an owner files bankruptcy because the lien rights are effective, albeit inchoate, to date of construction contract with owner (pre-bankruptcy).
February 19, 2009Construction Law Seminar
Lien Claims in Bankruptcy
Stay is lifted after 90 days if no plan or payments to lender.
Can proceed with foreclosure and sale of project.
Property subject to a mechanics lien can be sold, but the lien attaches to the proceeds of the sale.
February 19, 2009Construction Law Seminar
Lien Claims in Bankruptcy
Priority of mechanics liens versus lender’s mortgage or deed of trust analysis the same as non-bankruptcy setting.
Priority analysis depends on jurisdiction.Often depends on date of contract compared to date mortgage or deed of trust recorded.
Many jurisdictions permit contractors to agree to subordinate lien rights to lender’s mortgage or deed of trust.
To bind subcontractors, they must have notice.
February 19, 2009Construction Law Seminar
Lien Claims in Bankruptcy
What rights does the contractor’s bankruptcy estate have to retainage?
Typically not the property of the contractor’s estate.
Entitlement to retainage the same as pre-bankruptcy.
February 19, 2009Construction Law Seminar
Termination of the Contractor
Contractor bankruptcyCan still be terminated for convenience if contract permits.
Should seek bankruptcy court approval for termination for cause.
Will need to evaluate the cost and ease of termination for convenience versus cause.
February 19, 2009Construction Law Seminar
Termination of the Contractor
Owner bankruptcyOwner will have right to assume or reject the contract.Lender will have input.Factors to consider.
Conventional wisdom is not to change horses mid-stream.Permit issues.Demobilization and mobilization costs.Whose warranty governs what.New contractor premium.If EPC contract, who owns the engineering.Is the existing contractor making unreasonable demands.Easier to change if at easy breaking point.
Track completion costs versus warranty and punchlist costs.
Construction Law SeminarFor Lenders in Troubled Times
Construction Law Seminar
DLA Piper – Washington, DC
February 19, 2009
ENFORCING LENDERS’ RIGHTSAND MINIMIZING RISKS AND LIABILITIES
Fred Klein Kevin Kobbe
February 19, 2009Construction Law Seminar
Overview
Introduction
Enforceability of Commitments to Fund
A Binding Oral Commitment to Fund
Practice Tips
Withdrawal from CommitmentsMaterial Adverse Change
Force Majeure
Conditions Precedent
Renegotiating Commitments and Loan Agreements
Pitfalls
Practice Tips
Discretion to Make Advances
Borrower ClaimsCauses of Action
Damages/Remedies
February 19, 2009Construction Law Seminar
Introduction
February 19, 2009Construction Law Seminar
Introduction
The unprecedented turbulence in the credit markets, and the lack of liquidity have caused lenders to re-evaluate their lending practices
Often these evaluations include a comprehensive review of their current commitments and loan agreements, particularly those that may be “out of the money”
These difficult times also require more disciplined approaches to loans in default
Even the most proactive and effective precautions may not insulate lenders from litigation in the current environment
There are, however, things that can be done now to minimize the threat of litigation and mitigate any resulting exposure
February 19, 2009Construction Law Seminar
Enforceability of Commitments to Fund
February 19, 2009Construction Law Seminar
Enforceability of Commitments to Fund
An oral commitment to fund is binding if: Material terms are sufficiently definitive:
Duration or maturity date of loan/leaseInterest rate or formulaMode of repayment (installment v. lump sum)Collateral
Mutual assent
No express reservation not to be bound without a written contract
Partial performance (fee/advance)
BUT, in many states, Credit Agreement Acts or Statute of Frauds will bar oral commitment claims
Credit Agreement Act can bar tort claims too in some states
February 19, 2009Construction Law Seminar
Oral Commitments & The Parol Evidence Rule
Courts often consider parol evidence to decide whether there was an oral commitment
Examples:Witness testimony
Emails and other correspondence
Notes
Compensation and self-evaluation memoranda
Industry custom and practice
Course of dealing
Partial performance
He said/she said can preclude summary judgment
February 19, 2009Construction Law Seminar
Practice Tips for the Loan Team
A savvy loan team can be the first (and best) line of defense against unintended oral agreementsIt is important to educate the loan team on what creates a binding oral agreementWhat can you do?
Confirm all agreements in writingEmphasize that oral communications do not constitute an agreement and that any agreement is subject to the approval of senior management and a signed written agreementIf the loan officer keeps notes, the notes should reflect that the borrower was advised that any agreement is subject to the approval of senior management and a signed written agreementAvoid conjecture: “If you can get your cash flow in shape, we can do a deal”All terms and conditions are important, especially financial covenants
February 19, 2009Construction Law Seminar
When Must a Commitment Letter Lead to a Full Commitment?
A commitment letter “does not guarantee that the final contract will be concluded if both parties comport with their obligation,as good faith differences in the negotiation of open issues may prevent a reaching of final contact.” (Teachers Ins. & Annuity Ass’n of Am. v. Tribune Co., 670 F. Supp. 491, 498 (S.D.N.Y. 1987)).But a lender cannot justify a withdrawal of its commitment simply by proving that the deal did not close. Rather, the lender must use “reasonable efforts to advance [the] primary goals of [the] contract.” (See, e.g., Dalton v. Educ. Testing Service, 87 N.Y.2d 384, 389 (N.Y. 1995)).A lender may not act “arbitrarily or irrationally” in exercising its discretion to enforce its contractual rights. (GECC v. D’Agostino, 2005 WL 1683531, at *2 (S.D.N.Y. July 18, 2005)).
February 19, 2009Construction Law Seminar
Withdrawal from Commitment Good Protection
Sample protective language:“This proposal constitutes only a general, non-binding expression of interest on the part of Lender. THIS PROPOSAL IS SUBJECT TO LENDER’S CREDIT, LEGAL AND INVESTMENT APPROVAL PROCESS AND IS NOT INTENDED TO, AND DOES NOT, CREATE A LEGALLY BINDING COMMITMENT OR OBLIGATION ON THE PART OF LENDER. The creation of such a legally binding commitment or obligation is subject to, among other things, the completion by Lender of an in-depth investigation of the proposed investment, the results of which are deemed satisfactory by Lender and the negotiation, execution and delivery of definitive documents which shall be mutually agreed upon by all parties. IT IS UNDERSTOOD THAT NO PARTY HERETO SHALL BE LEGALLY BOUND TO THE OTHER BY REASON OF THIS LETTER, NOR SHALL RIGHTS, LIABILITIES OR OBLIGATIONS ARISE AS A RESULT OF THIS LETTER”
February 19, 2009Construction Law Seminar
Withdrawal from CommitmentBetter Protection
Even proposals should include integration clausesSimilar language regarding non-binding nature of proposal
Includes the following integration clause: “BY ACCEPTING THIS PROPOSAL, BORROWER ACKNOWLEDGES THAT THIS LETTER CONTAINS THE ENTIRE PROPOSAL FOR THE LOAN AND SUPERSEDES ANY (IF ANY) ORAL OR WRITTEN PROMISES, AGREEMENTS OR UNDERSTANDINGS REGARDING THE LOAN THAT ARE OUTSIDE OF THIS LETTER, NONE OF WHICH MAY BE LEGALLY ENFORCED. THE TERMS OF THIS PROPOSAL MAY BE CHANGED ONLY BY A SUBSEQUENT WRITTEN AGREEMENT MUTUALLY EXECUTED.”
BUT BEWARE, integration clauses can be overcome by course of conduct
February 19, 2009Construction Law Seminar
Withdrawal from Loan Agreements –Material Adverse Change
February 19, 2009Construction Law Seminar
Withdrawal from Loan Agreements –Material Adverse Change
Material Adverse Change (MAC) means a “significantly disadvantageous situation” in the life of the borrower, the market sector, the capital markets, or the financial markets generally
Wording of the MAC can be criticalIs it directed specifically at the borrower’s business or financial condition? (e.g., Business MAC)
OR is it more broadly worded:Borrower’s prospectsBorrower’s industry sectorCapital marketsFinancial markets more generally (Market MACs)
February 19, 2009Construction Law Seminar
Withdrawal from Loan Agreements –Material Adverse Change
Kena Properties LLC v. Merchants Bank & Trust, 2007 WL 627382 (6th Cir. 2007) (Ohio law)
Two commitment letters for refinancing of investment properties in Ohio and a revolving line of creditMAC Clause: “This commitment may be deemed null and void if there are any material adverse conditions with respect to the Borrower that occur before the closing”Borrower was sued for mortgage fraud prior to funding dateLender invokes MAC Clause to avoid fundingCourt held MAC occurred because of “the virtual certainty that it would affect the financial position of the borrower”Contrast: “Many commentators have noted that Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement.” Hexion Spec. Chem. v. Huntsman Corp., 2008 Del. Ch. LEXIS 134, *52 (Sept. 29, 2008 Del. Ch.).
February 19, 2009Construction Law Seminar
Withdrawal from Loan Agreements –Material Adverse Change
Sinclair Broadcast Group Inc. v. Bank of Montreal, 1995 U.S. Dist. LEXIS 1969 (S.D.N.Y. Feb. 21, 1995)
Commitment letter to loan $25M and serve as arrangement agent for syndication of another $70M
MAC Clause: “No material adverse change in the business condition (financial or otherwise), performance, operations, properties or prospect of the Borrower or its Subsidiaries sinceDecember 31, 1990”
Borrower asks what is meant by MAC, and Lender allegedly advised “that the clause was not significant, and declined to define any particular level of performance required by [Borrower] in order for the financing to occur”
February 19, 2009Construction Law Seminar
Withdrawal from Loan Agreements –Material Adverse Change
Sinclair Broadcast Group Inc. v. Bank of Montreal (Cont’d)Borrower then signs Commitment Letter and pays non-refundable arrangement fee
Borrower provides lower projections to Lender
Lender invokes MAC Clause and Borrower sues Lender
Court refuses to dismiss claims without discovery because it is plausible that Lender “was motivated by the … non-refundable fee payment to withdraw from the deal at the first colorable sign offinancial instability. If this instability fell short of a [MAC] in [Borrower’s] financial position, then [Lender’s] withdrawal would be pretextual, and therefore in bad faith”
February 19, 2009Construction Law Seminar
Withdrawal from Loan Agreements –Material Adverse Change
The Market MACProtects against adverse changes in the markets generally
Date back to the 1970s and were not uncommon until recently
Given strong credit markets of last five years, Market MACs wererarely included in financing agreements
Following the disruption of credit markets in summer 2007 and more recent events, Market MACs are making a comeback
February 19, 2009Construction Law Seminar
Withdrawal from Loan Agreements –Material Adverse Change
Langley v. Prudential Mortgage Capital Co., 2007 WL 4365423 (E.D. Ky. Dec. 12, 2007)
Lender committed to loan $43.3M and offered rate lock
Market MAC in loan agreement: “[Lender] shall be under no obligation to make the Loan and [Lender’s] determination to close and fund the Loan shall be subject to [Lender’s] sole determination that there have been no material adverse change to (or disruption in): (a) financial, banking, loan syndication, securitization, or capital markets”
Borrower locked rate, but Lender refused to honor rate lock because, among other reasons, it claimed disruption in credit markets in summer 2007 was a material adverse change
Court rejected MAC argument and agreed with Borrower that rate lock was intended to “remove any risk [to the Borrower] that adverse changes in the capital markets could affect the interest rates on the loans”
February 19, 2009Construction Law Seminar
Withdrawal from CommitmentForce Majeure
Force majeure means extraordinary events beyond the control of the parties
Subject matter of contract is destroyed OR
Means of performance is destroyed so as to make performance objectively impossible
Must be written into the agreement; there is no oral force majeure
Can the dramatic change in the capital and financial markets constitute a force majeure?
Trump v. Deutsche Bank Trust Co. (N.Y. Sup. Ct. 2008)TRO deniedCase pending
February 19, 2009Construction Law Seminar
Withdrawal from Commitment Force Majeure (Cont’d)
U.S. Bancorp. Equip. Fin., Inc. v Ameriquest Holdings, LLC, 2004 WL 2801601 (D. Minn. 2004) (applying New York law)
Borrower defaults under airplane lease agreement following 9/11Lender foreclosed and sold airplanes and sued Borrower for deficiencyBorrower invoked force majeure clause, claiming collapse of the aircraft market following 9/11 rendered performance impossibleCourt held that force majeure clause as written did not protect Borrowers, only Lenders, AND“The crash of the airline and airplane industry does not rise to the level of impossibility demanded by New York law. Certainly 9/11 radically depressed the market for airplanes. However, decreased value ofcollateral is not contemplated by New York law as an excuse for lack of performance based on impossibility. As New York courts have made plain, the fact that a contract proves to be unprofitable or onerous for one party does not excuse performance.” (Emphasis added.)
February 19, 2009Construction Law Seminar
Withdrawal from Commitment Other Conditions Precedent
Lenders should emphasize conditions precedent to any commitment to loan
Lender due diligence/underwriting approval
Execution of final loan documents
Closing by date certain
Cross default on material obligation
But, lender must always act in good faith and not arbitrarily and capriciously
It is important to clearly and consistently document the basis for the withdrawal in writingCourts will look to contemporaneous documentary evidence to determining whether decision to withdraw was in good faith or pretext
Also, lender cannot be the cause of the failure of the condition precedent
February 19, 2009Construction Law Seminar
Renegotiation of Commitments and Loan Agreements – Pitfalls
February 19, 2009Construction Law Seminar
Renegotiating Commitments and Loan Agreements – Pitfalls
Borrowers may misinterpret attempts to renegotiate as repudiation
Examples:“We can never fund that deal at that rate”
“We are never going to be able to make the deal on those terms”
“Given the market conditions, we can’t continue in this loan”
“If you don’t renegotiate, we will default you and terminate”
February 19, 2009Construction Law Seminar
Economic DuressMarket Condition or Bad Act?
Borrowers sometimes assert that the lender exercised “economic duress” in the renegotiation of commitments or loan terms
Economic DuressGenerally, a claim for economic duress is very difficult to establish because “when two commercial parties enter into an agreement, one of them [often] has a decided economic advantage over the other. The weaker party must enter into the bargain because of his economiccircumstances, a disparity in bargaining power to his disadvantage of some combination of the two.”(VKK Corp. v. NFL, 244 F. 3d 114, 123-24 (2d Cir. 2001)).
In short, the party must establish that it was denied its right to exercise its own free will and was unable to seek relief in Court at the time. For example, an economic duress claim may be sustained where the lendor insisted on raising the previously agreed upon interest rate without providing the counter-party with any additional benefit.
February 19, 2009Construction Law Seminar
Economic Duress Market Condition or Bad Act? (Cont’d)
The party asserting the claim must act quickly to seek relief from a Court – waiting a matter of months has resulted in dismissal of the claim. (Broadway LLC v. Credit Suisse First Boston Mortgage Capital LLC, 2001 WL 410074, at *2 (S.D.N.Y. Apr. 23, 2001)).
The party must not enjoy the benefit of the bargain before repudiating the deal. (Barrier Sys., Inc. v. A.F.C. Enters., Inc., 264 A.D.2d 432, 433 (2d Dep’t 1999)).
February 19, 2009Construction Law Seminar
Tips for Reducing the Risk of an Economic Duress Claim
Pre-negotiation letters should be used if there is an existing loan in defaultIdentify ground rules for negotiation, including that senior management must approve any agreement and that any agreement must be set forth in a signed writingGood faith motives should be documented contemporaneouslyBe aware when there is more than the traditional borrower/lender relationship; for example:
Placement of managementFinancial/strategic advice providedAdditional fees have been charged/receivedSeparate loans are present or are being discussed in other matters
February 19, 2009Construction Law Seminar
Renegotiating Commitments and Loan Agreements – Practice Tips
“You Tube” rule – your sales team should assume that their conversations with customers will show up on You TubeDo not suggest in any way that the lender will not honor its commitments/contractsConfirm intent to perform current commitment/agreement in writing (email, letter, notes)Ensure that consideration is given for renegotiated termsObtain release from the borrower and guarantors as part of renegotiationOther contract protections
Jury trial waiverChoice of lawForum selectionIntegration clause
February 19, 2009Construction Law Seminar
The Clear Channel Opinion
BT Triple Crown Merger Co., Inc. v. Citigroup Global Markets, Inc., 2008 WL 1970900 (May 7, 2008 N.Y. Sup.)
Borrowers, Bain Capital and Thomas H. Lee, contemplated a leveraged buyout of most of Clear Channel’s stock Lenders armed Borrowers with a $22 billion Commitment Letter just before the summer of 2007As the credit market tightened and the buyout negotiations progressed, the Lenders allegedly recognized that the loan was “out of the money” and attempted to either withdraw from the commitment or renegotiate the terms of the financingBorrowers alleged that the Lenders sought to do so improperly by:
(a) threatening to back out of an unrelated loan to the Borrowers; (b) insisting that the Borrowers accept certain terms in the closing documents that were antithetical to the terms of the Commitment Letter;(c) taking steps to delay the leveraged buyout; and(d) failing to negotiate the final terms in bad faith (i.e., making unreasonable demands)
February 19, 2009Construction Law Seminar
Clear Channel Opinion (cont’d)
BT Triple Crown Merger Co., Inc. (Cont’d)Borrowers filed suit against the Lenders in New York state courtfor breach of contract, fraud, unfair trade practices and civil conspiracy
The same day, Clear Channel (buyout target) obtained an ex parteTRO from a Texas state court enjoining Lenders from interfering with the merger agreement, including “refusing to fund the [Acquisition] as agreed in the Commitment Letter.”
Discovery unearthed damaging internal Lender e-mails:“Let’s draft the nuclear version” of the closing documentsDescribing plan to send “draconian docs” to the Borrowers“Time to take the gloves off”
Coupled with the non-performance of the loan, these e-mails raised an issue of fact as to Borrower’s anticipatory breach claim
February 19, 2009Construction Law Seminar
Discretion to Make Advances
February 19, 2009Construction Law Seminar
Discretion to Make Advances
Depends on the terms of the agreement
Loan Agreement: “Debtor acknowledges and agrees that any Advance made pursuant hereto shall be at Secured Party’s sole discretion and that no Advance will obligate Secured Party to make any Additional Advance.” (emphasis added)
Still requires good faith
February 19, 2009Construction Law Seminar
Discretion to Make Advances (Cont’d)
Yankton Production Credit Ass’n v. Larsen, 365 N.W.2d 430 (Neb. 1985)
Credit agreement provided sole discretion and that “nothing shall be construed to obligate [Lender] to make advances”Lender advanced only one-half of the funds requested by BorrowerBorrower defaulted, and Lender sued Borrower; Borrower counterclaimed that refusal to advance caused default and other damagesLender policy, not in loan agreement, was to advance unless loancommittee decided not to advance based on loan performanceSummary judgment for Lender reversed and trial court ordered to examine whether Lender acted in good faith under UCC
Lesson: Cannot rely solely on loan documents; must examine discoverable facts and lender practices and policies
February 19, 2009Construction Law Seminar
Discretion to Make Advances (Cont’d)
K.M.C. Co. v. Irving Trust Co., 757 F.2d 752 (6th Cir. 1985) (applying New York law)
Lender extended $3.5M line of credit to Borrower
Lender decided that it would not lend the remaining $800,000 left on the line
Borrower sued claiming Lender's refusal to extend remaining credit without prior notice was bad faith that caused "death of the company"
Evidence sufficient to support jury verdict that Lender should have given Borrower prior notice before refusing to extend additionalcredit
February 19, 2009Construction Law Seminar
Discretion to Make Advances (Cont’d)
K.M.C. Co. (Cont’d)"[Lender's] abrupt refusal to advance funds to [Borrower] . . . amounted to a unilateral decision to . . . wind up the company. If [Lender] had agreed to advance the $800,000 but no more, and checks still had bounced, we would have a different case. But, given that [Lender] knew or should have known that the bank was adequately secured, and that if adequately secured it was [Lender's] policy that some period of notice would be due before financing was denied, [Lender's] action could only be justified if in some way [it] reasonably believed that it was necessary to protect the bank's interests."
Court noted that, had Lender given at least 48 hours notice to allow Borrower to find new financing, "we would be facing a different case”
See also Carrico v. Delp, 490 N.E.2d 972 (Ill. App. Ct. 1986) (implying reasonable notice before terminating line required even where loan agreement allows lender to terminate in sole discretion)
February 19, 2009Construction Law Seminar
Discretion to Make Advances (Cont’d)
Compare Kham & Nate’s Shoes No. 2 v. First Bank of Whiting, 908 F.2d 1351 (7th Cir. 1990) – Rejects KMC’s “duty of kindness”
Bankruptcy court held that bank acted “inequitably” by terminating advances that would have been secure even though the Bank had express right not to make additional advances.
Seventh Circuit reversed equitable subordination, holding that Bank need not do more than loan agreement required
“Knowledge that literal enforcement means some mismatch between the parties’ expectations and the outcome does not imply a general duty of ‘kindness’ in performance, or of judicial oversight into whether a party had ‘good cause’ to act as it did. Parties to a contract are not each others’fiduciaries; they are not bound to treat customers with the sameconsideration as their families. Any attempt to add an overlay of ‘just cause – as the bankruptcy court effectively did – to the exercise of contractual privileges would reduce commercial certainty and breed costly litigation.”
February 19, 2009Construction Law Seminar
Summary of Borrower’s Claims --Causes of Action
Breach of contract/Anticipatory breach
Bad faith/Breach of the covenant of good faith and fair dealing
Negligence or Negligent misrepresentation
Breach of fiduciary duty
Promissory estoppel/Detrimental reliance
Fraud
February 19, 2009Construction Law Seminar
Summary of Borrower’s Claims –Damages & Remedies
Direct damages (out-of-pocket)
Consequential damages
Lost Profits
Death of the Company
Punitive Damages
Practice Note: Check loan agreements for limitations on damages
Specific performance
Declaratory judgment
Reformation
Construction Law SeminarFor Lenders in Troubled Times
Construction Law Seminar
DLA Piper – Washington, DC
February 19, 2009