Managing risk in preparation for a church's loan approval takes savvy and careful planning.
Tim Lawrence · February 27, 2018
Danger Zone #3: No Payment and Performance Bonds
There are a variety of risk factors that contribute to the risk of a project not being built to completion. One significant factor is the general contractor’s financial health.
What happens when the general contractor goes belly up during a project and declares bankruptcy?
It does not matter how iron clad the church’s contract with the GC is if the GC can no longer afford to pay their subcontractors or purchase materials for the project.
Payment and performance bonds, a type of surety bond, are an insurance product designed to protect the owner against the failure of the general contractor in the middle of a project.
In the event of the failure of a general contractor to perform on the contract, performance bonds pay the church, up to the amount of the bond, as compensation for the loss, allowing them to use the funds to complete the project. Payment bonds compensate the church if the contractor fails to pay subcontractors and suppliers.
Many contractors will try to convince churches that they don’t need these bonds for a project, and that bonds merely raise the cost of the project.
Bonds do raise the initial cost of a project, typically from 1 percent to 5 percent, depending on the market for bonds at the time, and the strength of the contractor obtaining the bond.
Since the contractor merely passes the cost of the bond to the church, why would the contractor recommend the church not take this prudent step to protect itself? One possible reason is that the contractor doesn’t financially qualify for the bonds.
Another reason is that although the contractor may have bonding capacity, that capacity is at its limits, meaning that they can’t cover this project until they finish another project of the same size.
Either way, the church may want to consider partnering with a contractor who has the ability to provide payment and performance bonds for the project. If the contractor for your project cannot provide payment and performance bonds, then your lender may be hesitant to loan on the project.
Danger Zone #4: Broken Lien Priority
As a part of the construction process, all the parties that are contracted to work on the property or supply materials to the property have the right to file mechanics liens on the property to ensure that they are paid for the work or materials supplied to the project.
When they are hired they will typically file a notice that documents their right to file that lien. When the work is done and they are paid what they are owed, they will then file a lien release. When a lender provides a construction loan, it is with the understanding that they will be in first lien position, and that mechanics liens are filed after the lender’s lien, meaning that the lender will have first priority in legally moving on the collateral to collect their debt in case the borrower defaults. Then those who filed mechanics liens would have secondary rights to the collateral if they were not paid.