Without a doubt, loaning to borrowers will always be a risky business to venture into. In particular, private construction lenders face more risks than usual. For example, by betting on a construction project, private lenders have to ignore the possibility that the project might not see the light of the day. Even though many states offer protection to lenders through legislation, the reality remains that lenders to private construction projects can be thrown into difficult situations when borrowers pull out halfway. In other situations, the lender is exposed to third-party liabilities when they play the role of joint venturer with the borrower. What are the possible ways lenders/brokers can expose themselves unknowingly to third-party liability?
Private Lenders As General Contractors
In situations where a project gets foreclosed halfway, private lenders can take over the construction. Alternatively, they could find a way to reach an agreement to buy out the development tract. This is rarely ever done as a matter of choice. In most cases, it’s done out of necessity. Taking over as general contractor and working out a contract for a subcontractor to finish the project is a course of action that leaves the lender open to liabilities, mostly when construction defects arise.
Joint Venture Lender
Private lenders sometimes act as joint financiers of a project instead of merely being a lender to the financier. Being a working partner can expose the lender to considerable liabilities. Ordinarily, it is difficult to legally prove that a lender is liable to share in losses during a construction project. However, in cases where the borrower pulls out of a project, the private lender often becomes the chief bearer of risks.
Protect Yourself From Liability
Yes! As general contractors, a lender can draw up legal agreements that could see them ineligible to be held liable for construction defects when they take over the construction of a project. Therefore, let your loan documents cover every possible aspect, including what will happen in the event of a foreclosure. Also, always think twice about taking up an unfinished project. Always consult with your attorney before making such decisions.
Lastly, be conscious that brokers could be liabilities, too, but as a lender, you can make them accountable through their fiduciary duty to protect you as their private investor.
To learn more about liabilities and how you can protect yourself against them as a lender, click here.
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