Recent Developments Regarding Construction Loans

By: James C. Busch

On June 24, 1994, the Georgia Court of Appeals heard a case involving a homeowner’s claim of breach of duty regarding a bank’s handling of a construction loan. The case, Peterson vs. First Clayton Bank & Trust Co., No. A94A0260, 94FCDR2405, held that the bank had no obligation to ensure that subcontractors and materialmen on the construction of a house were paid before making disbursements of loan proceeds to the builder.

In Peterson, the Petersons signed a contract with a builder to construct a house in North Georgia and obtained a loan from First National for the project. Since the Petersons lived in Florida, First National agreed to make disbursements from the loan to the builder. The builder failed to pay its subcontractors, the Petersons were sued by one of the suppliers and the Petersons filed a third-party action against First National. The Petersons were unable to satisfy the liens place on their property and defaulted on their construction loan. As a result of their default, the bank foreclosed on the Petersons’ property.

The trial court held there was no evidence that the bank promised it would ensure suppliers to the project were paid. The court held that the bank merely promised to disburse the loan proceeds to the builder and to monitor the construction and the duties outlined in the construction loan agreement. The court further held that ensuring the materialmen and subcontractors were paid by the builder was not a condition of the loan agreement.

In reaching the above holding, the Georgia Court of Appeals found that the construction loan agreement between the parties expressly authorized and directed the bank to pay loan proceeds to the builder and provided that the bank “has no liability or obligation in connection with the project or the construction and completion thereof, except to advance loan proceeds as agreed in this document and the bank is not obligated to inspect any improvements, nor is it liable for the performance or default of any contractor or subcontractor or for any failure to construct, complete, protect or insure said improvements or for the payment of any costs or expenses incurred in the project.”

The Petersons argued that the bank deviated from the above provision by agreeing to pay the builder and monitor the progress of construction. The Petersons argued that pursuant to O.C.G.A. 13-4-4, a duty was imposed upon the bank to verify payment of materialmen and subcontractors before disbursing loan proceeds to the builder.

However, the Court of Appeals disagreed by finding that there was no evidence that the bank promised to ensure all materialmen and subcontractors were paid before loan proceeds were disbursed to the builder. The Court of Appeals held that there could not be an implied contract as claimed by the Petersons since “it is only when the parties themselves do not expressly agree, that the law interposes and raises a promise”.

The Court of Appeals went on to state that although the bank agreed to accommodate the Petersons by making payments directly to the builder, there was no evidence that the bank agreed to obtain lien waivers, or payment affidavits or otherwise ensure that suppliers were paid before disbursing funds to the builder.

The Peterson case helps to clarify that there may be an obligation on lenders to monitor construction projects, but only when required by statute or expressly required. In Peterson, the bank never expressly agreed to the monitoring of the property and the Petersons failed to monitor the project which resulted in the financial mishap.

As a result of Peterson, it is now clearer who is responsible for project management and its resulting liability. In addition, as a result of Peterson, those who fail to monitor their project assume the risks for said failure. All lenders and property owners should clearly understand who is responsible for what in any given project and not assume that someone else is protecting a parties’ interests.

Mr. Busch is an attorney specializing in commercial and construction litigation for Busch, Reed, Jones & Leeper, P.C. in Marietta, Georgia