Construction Loan Funding and Title Insurance: Best Practices in Disbursement and Documentation

Presenting a live 90-minute webinar with interactive Q&A Construction Loan Funding and Title Insurance: Best Practices in Disbursement and Documentation Drafting Effective Future Advance, Budgeting and Draw Provisions; Lien Waivers, Title Updates and Endorsements TUESDAY, SEPTEMBER 12, 2017 1pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Peter G. Freeman, Partner, Pillsbury Winthrop Shaw Pittman, Washington, D.C. & New York Euchung Ung, Partner, Kleinberg Kaplan Wolff & Cohen, New York The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.

Tips for Optimal Quality FOR LIVE EVENT ONLY Sound Quality If you are listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory, you may listen via the phone: dial 1-866-570-7602 and enter your PIN when prompted. Otherwise, please send us a chat or e-mail sound@straffordpub.com immediately so we can address the problem. If you dialed in and have any difficulties during the call, press *0 for assistance. Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

Continuing Education Credits FOR LIVE EVENT ONLY In order for us to process your continuing education credit, you must confirm your participation in this webinar by completing and submitting the Attendance Affirmation/Evaluation after the webinar. A link to the Attendance Affirmation/Evaluation will be in the thank you email that you will receive immediately following the program. For additional information about continuing education, call us at 1-800-926-7926 ext. 35.

Program Materials FOR LIVE EVENT ONLY If you have not printed the conference materials for this program, please complete the following steps: Click on the ^ symbol next to Conference Materials in the middle of the lefthand column on your screen. Click on the tab labeled Handouts that appears, and there you will see a PDF of the slides for today's program. Double click on the PDF and a separate page will open. Print the slides by clicking on the printer icon.

Construction Loan Funding and Title Insurance: Best Practices in Disbursement and Documentation Euchung Ung Member Kleinberg Kaplan Wolff & Cohen, P.C. 212.880.9809 eung@kkwc.com 2017 KKWC All Rights Reserved.

Construction Loans Examples: Ground-Up Construction borrower purchases vacant land or existing developed property and demolishes the improvements, and constructs a new building on the land. Renovation or Refurbishment borrower upgrades an existing developed property, or converts it to a different use, such as recladding an old office building to make it more energy efficient or turning a hotel property into a residential condominium. Expansion or Existing Property borrower adds a new building to an existing property, such as adding a new outparcel building on a pad site in an existing shopping center. Tenant Improvements borrower requires funds to pay for tenant improvement work or for providing tenant with a landlord allowance to perform tenant improvements. 2017 KKWC All Rights Reserved. 6

Title and Survey Review title company and surveyor, with review and analysis by attorneys typically Environmental Report environmental engineers, with review and analysis by attorneys or client if required Soil Testing and Engineering civil engineering, with limited review or analysis by attorneys typically 2017 KKWC All Rights Reserved. 7

Title and Survey Review Environmental Report Soil Testing and Engineering Permitting and Zoning Review Appraisal Construction Budget Construction Schedule General Contractor and Development Manager Diligence 2017 KKWC All Rights Reserved. 8

Permitting and Zoning Review What can be built now without additional entitlements What is the scope of the project What additional entitlements are required What is the timing and process for obtaining the entitlements What is the downside risk of not obtaining the entitlements What permits are required to begin construction What certificates are required to evidence completion Lawyers are typically closely involved. Understanding the information its impact is important in the loan documentation process 2017 KKWC All Rights Reserved. 9

Construction Budget Site Costs purchase price for the land, brokerage commissions, legal fees, title insurance costs, conveyance taxes, borrower s diligence costs, and costs to prepare the land for development Hard Costs cost of equipment, materials, labor, decorations, furniture, fixtures and equipment, and cabling systems, etc. Depending on the lender, some of these may need to be funded by borrower. Soft Costs examples include developer fees, engineering fees, architect fees, legal fees, marketing expenses, real estate taxes, finance charges, insurance premiums, permit fees, equipment rental fees. In some jurisdictions, hard costs and soft costs are defined by statute it is important to understand the statutory law relating to construction costs prior to drafting loan documents. 2017 KKWC All Rights Reserved. 11

Other Contracts Lien, bankruptcy, tax and UCC searches (GC/Development Manager) Bonding requirements (GC/Development Manager) Required Insurance (GC/Development Manager/Other Professionals) General Contractor s Agreement (e.g., AIA form or otherwise) or Development Management Agreement 2017 PROSKAUER/KKWC All Rights Reserved. 13

General Contractor or Development Manager Legal Aspects Lien, bankruptcy, tax and UCC searches Bonding requirements Required Insurance General Contractor s Agreement (e.g., AIA form or otherwise) or Development Management Agreement 2017 KKWC All Rights Reserved. 14

Sample list of Loan Documents: Promissory Note Loan Agreement Mortgage Assignment of Leases and Rents Assignment of Contracts, Licenses and Permits Subordination of Development Manager and Assignment of Development Agreement Cash Management Agreement Non-Recourse ( bad boy ) Carveout Guaranty Completion Guaranty Guaranty of Payment 2017 KKWC All Rights Reserved. 15

Examples of items typically required for Draw Requests: Hard Costs Statement - i.e., a reconciliation between the actual Hard Costs and the budgeted Hard Costs Soft Costs Statement - i.e., a reconciliation between the actual Soft Costs and the budgeted Soft Costs Cost Certification typically from the General Contractor or Developer, or the Architect Payment receipts from the Developer, General Contractor and all Subcontractors Proof of payment of all Hard Costs and Soft Costs covered by all previous Draw Requests Final Lien Waivers from the Developer, General Contractor and all Subcontractors for all sums advanced up to and including the previous Draw Request (to the extent not previously delivered pursuant to a prior Draw Request or otherwise) Conditional Lien Waivers for the current Draw Request i.e., lien waivers that state the payee waives its lien against the real estate if it receives the specified sum of money 2017 KKWC All Rights Reserved. 23

Customary General Conditions for Advances: No lien for the performance of work or supplying of labor, materials or services shall have been filed against the Land and remain unsatisfied or unbonded or as an exception to the title insurance policy insuring the Mortgage. No condition or situation shall exist at the Land which, in the reasonable determination of Lender, constitutes a danger to or material impairment of the Property or presents a danger or hazard to the public. The representations and warranties made in Article III shall be true and correct in all material respects on and as of the date of the Advance with the same effect as if made on such date. All terms and conditions of the Loan Documents required to be met as of the date of the applicable Advance shall have been met to the satisfaction of Lender. Lender shall have received all due diligence materials it reasonably deems necessary with respect to verifying the Borrower s identity and background information in a manner reasonably satisfactory to Lender. No Default or Event of Default shall have occurred and be continuing. 2017 KKWC All Rights Reserved. 24

Sample Loan Agreement Retainage Clause: Borrower shall (or shall cause Developer to) hold back from amounts payable to the General Contractor under the GC Agreement, and shall cause the General Contractor to hold back from amounts payable to each Subcontractor under each Trade Contract an amount ( Retainage ) with respect to the value of its work in place in respect of the Improvements, which shall not, at any time, be less than (i) [ %] of the aggregate Hard Costs theretofore incurred by Borrower with respect to the General Contractor or such Subcontractor, as the case may be, for work in place in completing construction of the first [ %] of the work to be performed by the General Contractor or such Subcontractor, as the case may be, with respect to the Improvements, as verified from time to time by Lender s Consultant pursuant to the provisions of this Agreement, and (ii) [ %] of the aggregate Hard Costs theretofore incurred by Borrower with respect to the General Contractor or such Subcontractor, as the case maybe, for work in place in completing construction of the last [ %] of the work to be performed by the General Contractor or such Subcontractor, as the case may be, as verified from time to time by Lender s Consultant pursuant to the provisions of this Agreement, such [ %] to be based upon the total budgeted Hard Costs for the work to be performed by the General Contractor or particular Subcontractor, as the case may be, as of the date of computation. Retainage will be withheld by Lender and released to Borrower upon Completion of Construction concurrently with the making of the Final Advance. 2017 KKWC All Rights Reserved. 25

WAIVER AND FINAL RELEASE OF LIEN Know All Men that in consideration of the final payment (the Final Payment ) of $[ ] (check #[ ]), in hand, paid to [ ], receipt of which is hereby acknowledged, and other good and valuable consideration by [ ], [ ] hereby forever releases and discharges [ ] from any and all liability, damage, cost, injury, attorney's fees, rights, claims, demands, actions, causes of actions, lien and lien rights which [ ] now has or might have against on account of furnishing labor, material or services for or incorporated into the following property: Client/Owners: [ ] Address: [ ] [ ] [ ] respectfully warrants that the contract status set forth above is an accurate statement, no other sums are claimed, that all laborers, subcontractors, and suppliers employed by [ ] have been paid in full all sums. With the Final Payment no such laborers, subcontractors, or suppliers is or will be entitled to claim or thereon for labor or materials furnished to or for the account of [ ]. [ ] By: Name: Title: Date:[ ] Acknowledgments 2017 KKWC All Rights Reserved. 26

Sample Requirements for Final Advances: Lender s Consultant and the Architect shall have certified to Lender that construction has been completed in a good and workmanlike manner, in accordance with applicable requirements of all Governmental Authority and substantially in accordance with the Plans and Specifications; To the extent required by applicable Governmental Authority for the use and occupancy of the Improvements, certificates of occupancy and other applicable Permits and releases shall have been issued with respect to the Improvements and copies thereof have been furnished to Lender. Lender shall have received a reasonably satisfactory as-built Survey showing the location of the Improvements. Lender shall have received a reasonably satisfactory final affidavit from the Developer or the General Contractor and full and complete releases of lien from the General Contractor and each Subcontractor to the General Contractor with respect to work performed and/on materials supplied in the Project. Lender shall have received a reasonably satisfactory set of as-built Plans and Specifications for the Improvements. Lender shall have received a reasonably satisfactory endorsement to its title insurance policy. 2017 KKWC All Rights Reserved. 28

Examples of where other Agreements where Construction Draw Provisions would apply: Mezzanine Loans Development Agreements LLC Operating Agreements or Partnership Agreements 2017 KKWC All Rights Reserved. 29

This material is provided for general informational and educational purposes only. The information contained in this material is subject to change without notice. The presenters undertake no obligation to update this material. 2017 KKWC All Rights Reserved. 31

Construction Loan Title Insurance Issues Pete Freeman Kelly Behr Pillsbury Winthrop Shaw Pittman LLP

BASICS OF LENDER S TITLE INSURANCE 33 Construction Loan Title Insurance Issues

Loan Policy of Title Insurance A loan policy of title insurance primarily insures that 1. the mortgagor owns the real estate that it is offering as security for repayment of the loan, 2. the mortgagor has the authority to mortgage the real estate, and 3. the mortgage has the required priority. 34 Construction Loan Title Insurance Issues

How Title Insurance Companies Mitigate Risk By performing a diligent and time-consuming search of land records Establish a chain of title Identify encumbrances, including Liens Easements Rights-of way Future interests 35 Construction Loan Title Insurance Issues

Identifying a Title Insurance Company Promptly engage a title agent or title insurance company If two policies are needed, promptly engage a different title agent or insurance company to spread risk Once engaged, a title agent or insurance company will issue a Title Commitment, which will include standard and recorded exceptions 36 Construction Loan Title Insurance Issues

Title Insurance Policy Endorsements Loan policies are modified by endorsements Endorsement availability varies per jurisdiction Generally, endorsements can do the following: Remove or modify the exceptions or the standard coverage Provide the insured additional comfort re matters that a title agent is comfortable underwriting (e.g., access, survey, and contiguity) Facilitate the assignment of the insured mortgage Facilitate the draw process 37 Construction Loan Title Insurance Issues

Costs of Title Insurance The cost is tied to 1. The Amount of the Policy Owner s Policy: Issued at acquisition closing in the amount of the purchase price Loan Policy: Issued in the maximum amount of the loan and liability decreases as the loan is paid 2. Endorsements Price can vary per jurisdiction Lender s and Borrower s counsels should be involved Future loan increases: Be wary of local rules 38 Construction Loan Title Insurance Issues

Basic Loan Title Insurance Policy Endorsements ALTA 3.2 (Zoning Land Under Development) ALTA 6 (Variable Rate Mortgage) ALTA 8.2 (Commercial Environmental Protection Lien) ALTA 9.7 (Restrictions, Encroachments, Minerals) ALTA 17 (Access and Entry) ALTA 17.2 (Utility Access) ALTA 18.1 (Multiple Tax Parcel - Easements) ALTA 19 (Contiguity Multiple Parcels) ALTA 22 (Location) ALTA 24 (Doing Business) ALTA 25 (Same as Survey) ALTA 26 (Subdivision) ALTA 27 (Usury) ALTA 28.3 (Easement Damage Land Under Development) ALTA 32 (Construction Loan Loss of Priority)/ALTA 33 (Disbursement) 39 Construction Loan Title Insurance Issues

CONSTRUCTION LOANS 40 Construction Loan Title Insurance Issues

Construction Loan Basics Provided for constructing improvements upon real property Disbursed primarily post-closing Liability (and property value) increase with each advance over time Title insurance must insure the lien priority of each advance 41 Construction Loan Title Insurance Issues

Mechanic s Liens Arise when contractors do not receive duly owed payment for furnished labor, services or materials, typically occurs when a development project fails The contractor files a lien against the real property for the amount owed in accordance with state law. The priority of the lien typically relates back to the date that the labor, services or materials were furnished by the contractor. If a mechanic s lien is filed, a lender could lose its lien priority in an advance of loan proceeds if the contractor s work began before the advance was disbursed. 42 Construction Loan Title Insurance Issues

Pre-closing Mechanic s Liens Three Approaches 1. The title insurer accepts an indemnity from the sponsor if the claim is for a small amount, is not part of a pattern and could be paid by the sponsor. 2. The title insurer accepts an indemnity from the sponsor per an agreement and requires the sponsor to escrow 125% of the claim amount with the insurer. 3. The title insurer requires the borrower to bond the claim pursuant to local law. 43 Construction Loan Title Insurance Issues

Lender Options in Construction Loan Default Ensure the liens are paid pursuant to completion or payment guaranty Ensure the liens are paid pursuant to payment and performance bonds Pay contractors as part of the foreclosure to complete the project quickly Foreclose out mechanic s liens 44 Construction Loan Title Insurance Issues

Scope of ALTA loan policy mechanic s lien coverage Certain endorsements extend coverage against a loss of priority of the insured mortgage to future mechanic s liens when there is limited or no priority for the mortgage lien over future mechanic s liens ALTA Series 32 Endorsement 32, 32.1, 32.2 ALTA 33 Title insurance can confirm that the draw process will not create additional risk of loss of priority Must remove the standard mechanic s lien exception from Schedule B, Part 1 Add the above endorsements Pending Disbursements Clause 45 Construction Loan Title Insurance Issues

ALTA 32 Series Endorsements Deletes Covered Risk 11(a), which insures against loss caused by the lack of priority of the mortgage over a mechanic s lien that resulted from work financed by the mortgage that arises before or after the Date of Policy Paragraph 3 of each endorsement adds coverage for construction loan advances but this coverage is subject to (1) Limitations in the endorsement (2) Limitations in the policy jacket (3) Listed title exceptions Insures the construction loan advance will not invalidate the mortgage Insures priority of the mortgage over encumbrances missed by the title insurer 46 Construction Loan Title Insurance Issues

ALTA 32, Paragraph 3(c) The lack of priority of the lien of the Insured Mortgage, as security for each Construction Loan Advance made on or before the Date of Coverage over any Mechanic's Lien, if notice of the Mechanic's Lien is not filed or recorded in the Public Records, but only to the extent that the charges for the services, labor, materials or equipment for which the Mechanic's Lien is claimed were designated for payment in the documents supporting a Construction Loan Advance disbursed by or on behalf of the Insured on or before Date of Coverage. 47 Construction Loan Title Insurance Issues

Other ALTA 32 Versions ALTA 32.1 Similar to the ALTA 32 but narrower Insures against the diversion of funds only if the title insurer paid the contractor directly or gave lender written approval to pay the contractor ALTA 32.2 Does not require the title insurer or the borrower (with the title insurer s written approval) to pay the contractor, unlike ALTA 32 and ALTA 32.1 Like the ALTA 32.1, it only covers payments made directly to a contractor (i.e. excludes payments to a general contractor, which then pay subcontractors) Generally not accepted by lenders but may be necessary if the title insurer has concerns about the sponsor 48 Construction Loan Title Insurance Issues

ALTA 33 Used in conjunction with the ALTA 32 series endorsements Advances the Date of Coverage up to the date of disbursement Allows for the inclusion of any new title matters identified in a title search, including mechanic s liens Prudent lenders will disburse construction funds only upon receipt of a clean ALTA 33 49 Construction Loan Title Insurance Issues

Additional Due Diligence Title Companies typically require the following information to issue ALTA 32 series and ALTA 33 endorsements: Non-start affidavits from the borrower and contractors Construction contract(s) Project budget Construction loan agreement Subordination from the general contractor to the lender Evidence of the appraised value Financial statements 50 Construction Loan Title Insurance Issues

Pending Disbursements Clauses Added at the end of Schedule B, Part I Provides that, pending disbursement of the full proceeds of the loan, the policy insures lien priority only to the extent of the amount actually disbursed, up to the full amount of the policy Allows for the policy coverage to increase as disbursements are made Requires that title is examined at the time of each disbursement so that new liens can be identified and discharged or subordinated before the disbursement 51 Construction Loan Title Insurance Issues

Summary The ALTA 32 series endorsements, ALTA 33 endorsement and pending disbursement clause can insure against mechanic s liens by tying coverage to a specific advance made through a process that ensures that all contractors to be paid from that advance are paid as required. 52 Construction Loan Title Insurance Issues

Survey Coverage Coverage is based on the survey provided at closing Should be sufficient to either (1) Remove the standard survey exception or (2) Narrow it to specific matters shown on the survey 53 Construction Loan Title Insurance Issues

Owner s Policies Borrower s counsel should stay involved Consider the amount to insure Title insurers recommend an amount that covers the property s purchase price plus the value of the completed improvements. Borrowers often only purchase an amount that covers the property s purchase price, so any equity the owner has (or builds through improvements) in the real property is not covered. If a borrower purchases an amount that exceeds the property s purchase price, the policy will include a pending improvements clause, which states that the coverage is equal to the actual value of the improvements at the time of any claim 54 Construction Loan Title Insurance Issues

Sample Pending Improvement Clause Pending such time as the improvements contemplated upon insured premises shall commence, liability under this policy is limited to the purchase price paid for the land; but as and when the erection of such improvements shall commence, liability hereunder shall increase, as the improvements progress, in the amount of the cost thereof, up to the face amount of the policy. 55 Construction Loan Title Insurance Issues

Pete Freeman 1200 Seventeenth Street NW Washington, DC 20036-3006 (202) 663-8606 peter.freeman@pillsburylaw.com Kelly Behr 1650 Tysons Blvd, 14 th Floor McLean, VA 22102-4856 (706) 770-7760 kelly.behr@pillsburylaw.com 56 Construction Loan Title Insurance Issues

Disclaimer This presentation is for informational and educational purposes only. This does not constitute legal advice or legal opinions. The opinions expressed herein are the opinions of the presenters only and do not reflect the opinions of Pillsbury Winthrop Shaw Pittman LLP. 57 Construction Loan Title Insurance Issues