There are times when an owner may want to sell their real property during a construction project. As an owner, what are the key issues you should consider? As the general contractor, what is likely to be requested by the owner and by the buyer’s lender? This blog post addresses some of the larger issues that will need to be resolved in the transaction and should provide a general roadmap of how to structure the process.
Point One: Should you sell during the construction project or delay the closing until completion?
The answer to this question will be driven by the size of the project, the willingness of the buyer to take over a construction project, the willingness of buyer’s lender to finance the purchase, and of course the contractor’s willingness to consent to an assignment of the construction contract. The easiest answer is to delay the closing until the construction is complete; however, the easiest answer may not meet the needs of all the parties. There are times when an owner wants to sell and a buyer wants to buy. In those cases, the goal is to get to “yes” without imposing unnecessary risk on any of the parties.
Point Two: Consent by General Contractor to an Assignment of the Construction Contract.
The general contractor will want to know the financial strength of the potential new owner before it consents to an assignment of the construction contract. If the new owner is a relatively known commodity within the community, then this may be a fairly easy task. As a general contractor, there are a variety of methods to determine the financial strength of the potential new owner. These methods are similar to determining the financial strength of a prospective new client or the hiring of a subcontractor. Typically a general contractor may request financial statements, run a D&B report on the buyer, review court records, or just do a Google search on the new buyer before agreeing to any consent.
Point Three: How to handle lien rights of the General Contractor, Subcontractors and Suppliers.
One issue that is sure to arise is what to do about the lien rights of the general contractor, subcontractors, and suppliers on the project. In many states, lien rights arise when work first begins on the project and relate back over time to such date. This is often called the “First Spade Rule.” Lenders and title companies want to know whether or not they will be protected from liens that arise after the acquisition of the property. While it may be impossible to provide full protection to the new owner from lien rights for work that occurred prior to the closing date, there is a method to provide some level of comfort that everyone has been paid through the closing date.
The first thing is to coordinate with the contractor, subcontractors, and suppliers to make certain they can stop work on the job a few days prior to the closing date. An owner should request a payment application from the general contractor that covers all work and material provided through the closing. The owner should also request lien waivers from the general contractor, subcontractors, and suppliers for all amounts paid and work performed through the closing date. These partial lien waivers will be delivered to the buyer and title company prior to closing. Care should be taken to instruct material suppliers not to deliver any materials when the contractors have stopped work on the jobsite. Delivering materials during such a time could establish lien rights not covered by the latest payment application.
Other potential issues include how to deal with change orders arising after the closing date and who is responsible for paying for such change orders. Should an escrow account be set aside to deal with potential nonpayment of subcontractors and suppliers by the general contractor for work conducted prior to the closing date? What about builders risk insurance for the new owner? Will all product warranties transfer to the new owner?
Take Away Points
These are just a few issues that should be considered when selling real estate during the middle of a construction project. With these points in mind, there is a way to structure the transaction so as to minimize the risk to all parties and close the deal.