By John H. Baker, Jordan Schrader Ramis
What happens when a development project runs out of money before the work is done? Today’s tight credit and uncertain market prospects cast a shadow of risk on once-promising projects.
Each party – a tapped-out developer, undersecured lender, or unpaid contractor or consultant – has a stake in the project. Each party can protect its stake by cooperating with the others to maximize the property’s value and minimize dispute costs.
To achieve the best outcome possible:
Determine the total value actually at risk
The typical project under review in this situation is unfinished, late and will require more money to finish than anybody expected to contribute. Given those factors, the parties need to realistically determine the value of the unfinished versus the finished project.
Whether or not the projected finished value is equal to the original pro forma appraisal isn’t the issue – the critical consideration is what its completion will contribute to the value.
Analyze options
The lender may face the burden of injecting more funds into the project than its authorized loan-to-value ratios. The owner or developer may have to liquidate other assets. Contractors may have to discount work or extend payment terms.
These analyses must consider the cost of further delay and litigation. The parties’ contractual rights to recover delay costs, attorney fees, appraisal costs and other expenses may not outweigh the cost of losing tenants or buyers because the project did not make it to market.
Parties must determine their bottom-line position
Each party may find itself unable to participate in a solution on a true pro rata or proportional basis. The owner or developer may have no other assets to liquidate or contribute. The contractor may face unpaid tax claims or other liens that threaten its ability to remain in operation.
But within the range of financial contributions that each party can accommodate, a workable solution can often be found.
How it might work: a recent case history
The project in question was 90 percent complete but the expected cost to finish would substantially exceed the original budgets. The owner’s resources were depleted, credit limits were maxed out and the contractor was owed a substantial sum.
The lender suspended funding, work stopped and the contractor filed its lien. But the contractor chose not to immediately exercise its right to terminate the contract and foreclose its lien, leaving room for all parties to maneuver.
After multiparty discussions, a contract change order ultimately led to completion. The contractor received more than 90 percent of its lien claim but agreed to an absolute maximum fixed cost to finish the work. The lender agreed to fund the final work, given the limit and received an additional supplemental guarantee for payment from the investors and the owner.
A short-term completion schedule was agreed to by all parties. Every party gave up something, but no party was forced to bear the total burden or expense of the problem. Finishing is obviously the ultimate goal of any construction project and should remain the goal even when problems develop.
Douglas P. Cushing is a member of Jordan Schrader Ramis’s business practice group. He can be reached at doug.cushing@jordanschrader.com. John H. Baker, AIA, LEED AP, is a member of Jordan Schrader Ramis’s Dirt Law practice group. He can be reached at john.baker@jordanschrader.com.
