Two things are certain in construction: (1) developers will obtain construction loans to finance the construction of their project and (2) there will unfortunately be bad projects where the developer’s lender forecloses on the (first priority) mortgage given in connection with the construction loan. Not only is this bad for the developer, but it is bad for contractors because the lender will look to foreclose (and wipe out) all inferior liens, such as unpaid contractors and suppliers’ liens (which will be inferior to the lender’s mortgage).
The case of CDC Builders, Inc. v. Biltmore-Sevilla Debt Investors, LLC, 39 Fla. L. Weekly D1997a (Fla. 3d 2014) illustrates a bad project where a lender moved to foreclose on a construction loan. But, unlike a more traditional example of the construction lender foreclosing, this case involved a hyper-creative attempt by the developer to purchase its own construction loan and then foreclose on the corresponding mortgage for the sole purpose of intentionally wiping out its general contractor’s lien.
In this case, the developer hired the contractor to build luxury homes. The contractor completed the homes, but the developer failed to pay the contractor for the last eight homes. The contractor recorded construction liens to collateralize its nonpayment. The developer was unable to pay off its construction loan due to a lack of luxury home sales. To avoid the lender foreclosing, the developer negotiated loan extensions where the developer was required to pay money to reduce the lender’s exposure on the loan. However, the developer did not want its payments to reduce the principal of the loan. Why? Because the developer wanted to ensure there would be no equity in the real property to satisfy the contractor’s liens. So, the developer negotiated with its construction lender to treat any money it paid the lender for loan extensions as junior liens against the property. The developer then had another company created. This other developer-related company purchased the construction loans from the construction lender in exchange for loan assignments. (This was done so the other company maintained a first priority interest with the real property since it purchased the original construction loans.) Once this other developer-related company purchased the construction loans, it moved to foreclose on the loans. Why? Because, by doing so, the developer could wipe out the contractor’s liens as inferior liens on the real property. Very creative and it actually worked as the trial court entered a final summary judgment of foreclosure in favor of this developer-related company (meaning the contractor’s inferior liens would be valueless based on the equity in the real property).
The Third District Court of Appeal reversed the trial court’s foreclosure judgment (as there were questions of fact as to whether the developer-related company was actually created by the same investors that controlled the developer). The Third District, employing a policy of fairness, held that:
“The law does not permit a person to borrow money from a bank, give the bank a mortgage, incur additional liens and junior mortgages on the property, purchase the mortgage back from the bank, and then foreclose on the mortgage for the primary purpose of eliminating the additional liens and junior mortgages.
[I]nvestors cannot grant mortgages, contract for the improvement of the property mortgaged, and then use a network of companies to purchase and foreclose the mortgage for the primary purpose of extinguishing the construction liens that increased the value of the property. To hold otherwise would undermine the long-standing principle…persons cannot do indirectly what they are not permitted to do directly.”
CDC Builders, supra.
Stated differently, and less eloquently then the Third District, the law does not permit a developer to undertake creative avenues to purchase the very mortgage and loan it originally obtained to finance its construction for the sole purpose of cheating its contractor out of payment for improving the real property. To find otherwise would simply give the developer a windfall since it would not have to pay for construction improvements that it wanted and which improved the value of its property.
Please contact David Adelstein at firstname.lastname@example.org or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.