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"Court Reminds Construction Lenders: Follow Your Contracts"

Banking Alert

In an opinion issued by the West Virginia Supreme Court of Appeals on September 16, 2010, White v. AAMG Construction Lending Center et al., Case No. 35286, the Court permitted a borrower plaintiff (“Borrower”) to pursue a breach of contract claim against a construction lender (“Lender”) for paying loan funds to a contractor (“Contractor”) for work that the contractor had yet to perform.

The terms of Lender’s loan agreement provided that Lender would “disburse funds only FOR WORK IN PLACE, based upon inspection.”  In short, Contractor was to be paid only for completed work. 

Following a draw request from Contractor, Lender learned that Contractor had not performed the work for which it was requesting the draw.  Initially, Lender only paid Contractor an amount equal to the work performed, but later, upon receiving subsequent draw requests from Contractor requesting payment for unperformed work, Lender paid Contractor for the unperformed work even when its inspection verified that the work was not completed. 

When Contractor quit working on the project, Borrower brought suit against Lender, alleging, among other things, that Lender breached the terms of the loan agreement by paying Contractor for work that had not been performed.  In remanding the case to the circuit courts, the Court held that there were questions for a finder of fact to resolve regarding whether Lender’s payment of Contractor’s draws for uncompleted work constituted a breach of the terms of the loan agreement.

The quick lesson for construction lenders: do not pay out draws for construction loans when you know that the work has not been performed by the contractor requesting the draw.  To do so could give rise to a breach of contract claim by a borrower if the operative loan agreement contains language permitting payments only for completed work.