Contractors are often asked to sign a contractor’s consent to collateral assignment of the construction agreement at the same time or shortly after signing their construction agreement. If everything goes well on the project, this document is of little concern. However, if the owner defaults on its loan obligations, the contractor’s consent to collateral assignment can be an extremely important document that carries with it significant consequences for the contractor. Many contractors learn the hard way just how important the consent to collateral assignment can be. The purpose of the contractor’s consent is to provide the construction lender with additional comfort and security in several different ways. These can include:
- Providing the lender with the right to step in and take over the project in the event the owner defaults. This includes the right to terminate the construction agreement without cause if it is in the best interest of the lender.
- Requiring the contractor to subordinate its lien rights to the mortgage of the lender.
- Requiring the contractor to acknowledge receiving and reviewing a copy of the loan agreement between the lender and owner. (This document can contain provisions that have significant consequences to the contractor and must be reviewed or the acknowledgment must be deleted.)
- Requiring the contractor to certify that all of the permits, approvals, plans and specifications have been received and are acceptable and complete and that the project can be built as contemplated.
However, the proposed first drafts of these consents rarely contain a clause that would provide for the contractor to be paid for the work and services performed for the owner prior to the lender’s exercise of its right to take over the project.
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Requiring the contractor to obtain prior written approval of the lender before performing change orders or extras exceeding some dollar amount individually and/or in the aggregate. The contractor’s failure to abide by such a commitment can result in a forfeiture of payment for such extras in the event the lender takes over the project. The overall effect of signing the consent as initially drafted is to increase the contractor’s risks and obligations and to decrease the contractor’s lien and payment rights. The good news is that the terms of these consents are generally negotiable. If you are asked to sign a contractor’s consent to collateral assignment you should review and fully understand the commitments and risks it entails. Better yet, have an attorney review the document and negotiate commercially reasonable terms, before you sign. Peter F. Herzog can be reached at Michael Best & Friedrich LLC at 312-222-0800 or by email.