December 6, 2022

Volume XII, Number 340


December 06, 2022

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December 05, 2022

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Supply Chain Disruptions Affect Construction Loans And Defaults

Since the beginning of the pandemic, supply chain issues have has an impact on every aspect of consumers’ lives. The supply chain breakdown has also severely affected the residential construction industry, from the procurement of lumber and structural steel to obtaining computer chips used in HVAC systems and other electronic components. Coupled with shipping delays, labor shortages and rising costs only add to the uncertainty in price and timing that is now common in construction projects.

The construction lending business relies on borrowers and contractors working together to meet timing and pricing deadlines set forth in their loan agreements. Failure to meet those deadlines will generally trigger a default under the terms of the loan documents. Most of those loan agreement and construction mortgage templates were drafted pre-pandemic and do not contemplate the impact of substantial delays in construction due to supply chain issues. 

Construction loan defaults on the rise

Supply chain issues have created a large number of defaults in the construction lending industry. A construction loan that is in default before completion puts the lender and borrower in a precarious position for a variety of reasons. Most construction loans do not allow for subsequent draws after the loan is in default, and the lender is forced to examine whether or not to foreclose on a partially completed project, attempt to modify the loan documents with the borrower, or waive the default by the borrower, permanently or temporarily. 

Moreover, a default that occurs in a rising interest rate environment will likely require the borrower to refinance the loan at a higher interest rate.   

The new, and challenging environment for construction lenders requires a proactive, hands-on approach to best mitigate risk and exposure to lenders. Lenders should consider working closely with their legal advisers to consider a review of their underwriting, documentation and servicing of construction loans, including:

  1. Reviewing existing template loan agreements and mortgages to determine if they meet the risk profile of the lending institution given the current, and expected construction environment. 

  2. Reviewing existing construction loan portfolio for loans that are currently in default for failure to meet deadlines set forth in the loan agreements. 

  3. Developing an outreach program for borrowers in jeopardy of defaulting on their construction loan. 

  4. Developing or modifying an existing construction mortgage modification program to contemplate the current market factors. 

It is imperative that construction lenders adapt to the changing market conditions to best protect themselves, to better serve their borrowers and to set themselves apart from institutions that continue to lend and service loans using procedures established in a pre-pandemic environment. Lenders must be proactive to identify an appropriate outreach to borrowers and a mortgage modification program that best fits their unique circumstance.

© 2022 BARNES & THORNBURG LLPNational Law Review, Volume XII, Number 244

About this Author

 Vincent P. Trace Schmeltz III, Barnes Thornburg Law Firm, Chicago and Washington DC, Corporate and Litigation Law Attorney

Trace Schmeltz is a partner in the Chicago office of Barnes & Thornburg LLP, where he is the co-chair of the firm’s Financial, Corporate Governance, and M&A Litigation Group and a member of the White Collar Crime Defense Practice Group. A trial attorney with experience in numerous forums including the Delaware Court of Chancery, he concentrates his practice on securities, commodities, mergers and acquisitions and white collar criminal litigation. In addition, he has pursued and defended claims on behalf of auditors, investment banks, corporate boards and corporations....

Michael Gottschlich Commerial Litigation Attorney

Complex commercial litigator Mike Gottschlich resolves major business, antitrust, lender, securities and director and officer liability disputes and claims. Mike is about getting results for clients. A dynamic negotiator, Mike is known for his ability to see the many different perspectives and angles of a dispute in order to identify and promote the right argument on his client’s behalf.

As national counsel for several companies involved in complex business litigation in both federal and state courts throughout the country, Mike’s work focuses...

Thomas M. Maxwell, Barnes Thornburg Law firm, Indianapolis, Corporate and Finance Law Attorney

Thomas M. Maxwell is a partner in Barnes & Thornburg LLP’s Indianapolis, Indiana office. He practices in the Corporate Department primarily in the areas of securities law, financial institution regulation and general corporate matters. He has acted as issuer’s and underwriter’s counsel in numerous offerings of securities including initial public offerings and private placements. He also regularly advises publicly-held companies and their directors on corporate governance matters, disclosure obligations and other matters under federal securities laws, including compliance with various...

Michael A. Cavallaro Financial Attorney Barnes and Thornburg

Michael Cavallaro advises banking and financial services companies on national and regional regulatory and legal compliance issues related to consumer and commercial bankruptcy and restructuring, collections, vendor management, foreclosure, loss mitigation and default servicing. Mike is a client-centered, creative problem-solver who focuses on providing efficient and effective representation.

A consummate team player, Mike is personally dedicated to navigating his clients through the challenges associated with an industry where laws and regulations are constantly evolving. Mike’s...