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Jeffrey B. Steiner and Dino Fazlibegu

Given the recent construction boom going on in New York City, commercial mortgage lenders need to be aware of the unique risks associated with making construction loans secured by property located in New York. Construction lenders understand the underwriting risks arising from the performance (or lack thereof) by the developer of its obligations under the construction loan documents, such as the occurrence of delays in completing the project, the failure to ultimately complete the project or the incurrence of costs in excess of the amounts budgeted for construction of the improvements. However, under New York law, construction lenders can also suffer losses vis-à-vis the developer’s construction contractors. In addition to the filing of a mechanic’s lien against the property, an aggrieved contractor that has not been paid by a developer may bring a claim for payment directly against the construction lender if the construction lender does not take certain precautionary steps to avoid such liability.

Limitations on Third-Party Rights

Contractors that have commenced litigation against developers for unpaid sums due to them under construction contracts with developers have at times also included such developers’ construction lenders as defendants. In such cases, the contractors generally argue that the construction lender breached a duty owed to the contractor. For example, the plaintiff in one recent New York case, MLB Constr. Servs., LLC v. Lake Ave. Plaza, NY Slip Op 32823(U) (Sup. Ct., Saratoga Co. 2016) brought an action against the defendant developer’s construction lender based on, among other things, breach of the building loan agreement and of the New York Lien Law. In particular, the building loan agreement between the defendant developer and the construction lender stated that the construction lender may, in its discretion, make loan advances directly to the general contractor or subcontractors as payment under the applicable construction contract instead of making loan advances to the developer. The contractor argued that such a provision is intended to benefit the contractor by imposing the obligation on the construction lender, generally, to ensure that loan proceeds are ultimately used to pay contractors and, specifically, that such proceeds should be paid directly to contractors.

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