Construction Loan Transactions (FL)

Praccal Guidance

A Practical Guidan

Practice Note by Elena Otero, Holland & Knight LLP

Elena Otero

Holland & Knight LLP

This practice note explores the key components of

construction loans in Florida. This note discusses the

purpose and structure of Florida construction loans, details

key terms used in construction loan transactions, and

provides an overview of construction loan documentation.

It also offers general best practices for lawyers representing

lenders or borrowers in such loans.

For more on construction loan agreements, see

Construction Loan Agreements. For a form of construction

loan agreement that you may modify for use in Florida, see

Construction Loan Agreements. For more on construction

loan term sheets and commitments, see Construction

Loan Term Sheets and Loan Commitments. For more

on draw requests, see Draw Request and Disbursement

Process in a Construction Loan. For more on due diligence

in construction loan transactions, see Due Diligence in

Construction Lending. For more on closing a construction

loan transaction, see Construction Loan Process and the

Closing.

Introduction and Basics

Construction loans are used by borrowers to finance

improvements to existing properties or ground up

construction of vacant land. These loans are usually

short-term in nature, with maturity of the construction

component being tied to the projected timeline for

the construction of the project, and sometimes have a

permanent term conversion component whereby, once

the lien-free construction of the project is successfully

completed, the construction loan becomes a permanent

term loan. This conversion to permanent financing depends

largely on the type of project being built. For example, a

conversion to permanent financing would be common in

the ground up construction of an apartment building or

remodeling of a retail development but would likely not

be available to a borrower/developer who is constructing

a condominium project and selling the condominium units.

Essentially, it is usually available, to the extent offered

by the lender on the deal, only in projects where the

borrower/developer is intending to hold the collateral and

stabilize the project rather than build and sell the project.

Generally, construction loans are advanced monthly or bi-

monthly based on draw requests made by the borrower

and certified by the lender’s construction consultant. These

draw requests are based on the budget for the project

provided by the borrower and approved by the lender,

usually prior to closing of the construction loan. Supporting

documentation for draw requests include paid receipts,

invoices, lien releases, statement of accounts, and other

documents as requested by the lender or its construction

consultant. Advances are made to the borrower only for

the approved costs in the draw request. Retainage is

usually withheld from each draw request and released in

accordance with the terms of the loan documents and

construction contract.

Depending on the magnitude of the project, these loans

usually mature anywhere from one to three years and

lenders are very sensitive to ensuring that the project is

both on time and on budget. Delays to the timeline can

be costly to borrowers and give cause for concern to

lenders. As in most contractual relationships and financing

transactions, communication between the parties is key to

construction loans and timely notice of unexpected delays

or budget changes to the lender is a best practice for

construction loan borrowers.

Key Terms

The following is an overview of key terms used in

construction loan transactions in Florida:

• Advances. See the overview of draws below. The terms

advances and draws are used interchangeably.

• Budget. A budget in a construction loan transaction is

the detailed line item budget of all construction costs,

including direct and indirect costs (which are also at times

called hard and soft costs) and land costs, and showing

the total costs for each line item and the amount of each

line item to be funded from the loan and/or borrower’s

equity requirement. Direct or hard costs are the direct

construction costs incurred by borrower in connection

with the project and indirect costs will be all other

costs. Lenders will always want to control revisions to

the approved budget and will usually have provisions in

the loan documents that limit increases to any line items

or the overall budget to keep the loan and project in

balance as underwritten.

• Carry guaranty. A carry guaranty is a guaranty in which a

guarantor agrees to “carry” the expenses of the property

and cover various obligations of the borrower, such as

utilities, taxes, insurance premiums, interest due, late

fees, and other fees under the loan, operating expenses,

maintenance expenses, management fees, marketing fees,

and other costs and expenses.

• Completion guaranty. A completion guaranty is a

guaranty in which a guarantor agrees that they will

achieve lien-free completion of the project, including

payment of all costs associated therewith, and also

perform and satisfy all other covenants and agreements

of the borrower per the loan documents.

• Construction documents. Construction documents

are composed of the construction contract with the

general contractor; all construction, architectural, and

other design professional contracts and subcontracts; all

change orders; all governmental approvals; the plans and

specifications; and all other drawings, budgets, bonds,

and agreements relating to the construction of the

project.

• Conversion to permanent financing. Some construction

loans will have a built-in option whereby the borrower

can convert their construction financing (which is short-

term financing that will mature upon completion of the

project) to permanent financing. Such loans will have loan

agreements that outline the conversion requirements, the

method by which a borrower can elect such conversion,

a conversion date, and the terms (such as the interest

rate, maturity date, term) of the permanent financing if

the loan is converted.

• Draws (also called advances). Draws refer to each

funding of a construction loan to a borrower by

lender subject to the terms and conditions of the loan

agreement. The loan agreement will generally state how

many draws will be made monthly (usually one to two

times per month) and that the draws will only be for

costs actually incurred for work in place as certified by

the lender’s inspector, and will require lien waivers,

releases, and other such proof of payment as well as a

title endorsement to the lender’s title policy, among other

items, for each draw to be made.

• Draw request (also called advance requests). A draw

request is a request by a borrower to receive an advance

under a construction loan. Such requests are usually on

AIA Forms G702 and G703 or another form approved

by the lender. Lenders will usually require that each draw

request include certain representations by the borrower.

As an example, a construction loan agreement may state

that:

o Each draw request will constitute a representation

by the borrower that the work done and the

materials supplied to the date of the request are in

accordance with the plans and specifications

o The work and materials for which payment is

requested have been physically incorporated into the

project

o The value is as stated

o The work and materials conform with all applicable

rules and regulations of the public authorities having

jurisdiction

o Payment for the items described in such request has

been made or will be made with the proceeds of the

advance for which the draw request was submitted

o The draw request is consistent with the budget

o The proceeds of the previous advance have been

actually paid by the borrower in accordance with the

approved draw request for such previous advance –

and–

o No event of default or event which, with the giving

of notice or the passage of time, or both, would

constitute an event of default has occurred and is

continuing

For more on draw requests, see Draw Request and

Disbursement Process in a Construction Loan. For forms

of draw request, see Draw Request and AIA® Document

G702™ — 1992 (Application and Certificate for Payment,

Sample Form).

• Equity requirement. Construction loans have what

is called an equity requirement component which

means that a borrower will be required to invest an

amount equal into the construction of the project. This

amount will be accounted for in the budget and will

be a percentage of the project costs. Most lenders will

require that the equity remain invested in the project

for the term of the loan and will restrict borrower from

reimbursing themselves, whether directly or indirectly,

for their equity investment. Most loans require that the

equity be spent before any advances are permitted,

but in some cases, lenders and borrowers may agree to

certain tranches of equity and loan advances as they see

fit for their particular loan and project.

• Force majeure. Force majeure references delay due to

acts of God, governmental restrictions or closures, stays,

judgments, orders, decrees, enemy actions, epidemics,

pandemics, civil commotion, fire, casualty, strikes, work

stoppage, shortages of labor or materials, or similar

causes beyond the reasonable control of borrower.

Most borrowers will want to add these such provisions

to construction loans to give themselves flexibility as

to items that may occur that are out of their control

and which could affect relevant deadlines. In turn, most

lenders will want to limit this applicability to ensure that

the project stays on track and will require timely notice of

the alleged force majeure event to ensure these items are

really outside of the borrower’s control.

• Loan balance/balancing. Construction loans usually

contain provisions requiring the loan to be in balance at

all times. These provisions permit lenders to determine

that the proceeds of the loan remaining to be advanced

for any line item within the budget are sufficient to

pay the amount of such line item remaining to be paid.

Further, these provisions state that if any deficiency

cannot be cured by a reallocation of budgeted amounts,

the borrower is liable for any such deficiency. Some

loans may call for a reserve account for such amounts

to be funded at the time the lender deems the loan out

of balance. Additionally, a loan being out of balance will

likely be an event of default.

• Payment and performance bond. Payment and

performance bonds are two separate bonds that are

companions to each other and cover certain obligations

under the construction contract. The performance bond

secures the contractor’s performance obligations under

the construction contract. The payment bond protects

against nonpayment in favor of certain subcontractors,

materialmen, and other laborers on the project. These

bonds are typically required to be in the form of AIA

Document A312 without modification or revision, other

than as acceptable to the lender. Lenders usually require

that the surety be reasonably satisfactory to lender,

be licensed or authorized to do business in the state

where the property is located, and name lender as a dual

obligee pursuant to a dual obligee rider to the bond. It

should be noted that these bonds are underwritten on

the creditworthiness of the general contractor. In some

construction loans, borrowers will ask to bond only

certain major subcontractors (to be defined by value

of contract or specialty or otherwise as agreed to by

the borrower and lender) in lieu of bonding the general

contractor’s construction contract. This ask is sometimes

tied to the associated expense of these bonds, having an

affiliated general contractor on the project, or having a

general contractor who is not able to be bonded.

• Plans and specifications. The final plans and

specifications include all maps, sketches, diagrams,

surveys, drawings, and lists of materials for the

construction of the project, prepared by the architect for

the project, as acceptable to the lender. The plans and

specifications will be approved by lender and any changes

to them will also require lender’s consent. The plans and

specifications are an item that the lender’s inspector will

review.

• Lender’s inspector (also called lender’s construction

consultant). Construction loans have an inspection

component whereby a lender has the right to retain, at

borrower’s expense, an inspector to act as a lender’s

consultant in connection with the loan and the

construction of the project. The inspector will review

and advise lender with respect to the construction

documents, and other matters related to the design,

construction, operation and use of the project. The

inspector will monitor the progress of construction, and

review advance and change order requests.

• Notice of commencement. A notice of commencement

is a document recorded in the public records prior to

commencement of construction on a project. The notice

of commencement should comply with Fla. Stat. § 713.23

and include:

o The legal description of the property

o A general description of the project

o The name and address of the owner

o Their interest in the property

o The fee simple titleholder of the property, if not the

owner

o The name and address of the contractor

o The name and address of the surety on the payment

bond and attach a copy of the bond –and–

o The name and address of the lender

Fla. Stat. § 713.23 further requires that:

a lender must, prior to the disbursement of any

construction funds to the contractor, record the notice

of commencement in the clerk’s office . . . ; however, the

lender is not required to post a certified copy of the notice

at the construction site. The posting of the notice at the

construction site remains the owner’s obligation. The failure

of a lender to record the notice of commencement as

required by this subsection renders the lender liable to the

owner for all damages sustained by the owner as a result

of the failure. Whenever a lender is required to record a

notice of commencement, the lender shall designate the

lender, in addition to others, to receive copies of notices to

owner.

• Reallocation. Reallocation is the act of moving amounts

from one line item in the budget to another, usually as to

line items savings and requiring the consent of the lender

in most construction loans.

• Reserves. Reserves are amounts required by a lender to

be held in specific accounts, sometimes to be restricted

accounts, as additional collateral and to account for

possible project overruns, such as contingency reserves

to allow for loan balancing issues or cost overruns and

stabilization reserves that are held to ensure that loan

payments are made during the period in which the

borrower is working on leasing out the project to stabilize

same.

• Retainage. Retainage is amounts held back by the

borrower from the general contractor and subcontractors

on each draw. It can be a percentage of the costs of

construction or a specific amount actually to be held

back from each draw. Retainage is usually 10% of

construction costs, but there are times where other

amounts are negotiated or there is a system in place

where retainage starts at a certain percentage but drops

off as construction progress is made and completion is

approached. The retainage is held by the lender until the

final advance on the entire project is made, but in some

instances is released as each discipline’s final advance on

the project comes due.

• Stabilization. Stabilization is achieved when the

construction of the project has been completed and

the project has been leased by third-party tenants to a

certain agreed-upon threshold, is generating positive

net income, or is able to meet a certain debt service

coverage ratio. The metric will be lender- and project-

specific but a key component is that the lien-free

construction of the project is complete, and tenants are

beginning to occupy the project.

Construction Loan

Documents

A Florida construction loan will have many of the same

loan documents that can be found in a mortgage loan,

but it will include certain construction loan-specific

documents. As with most loans, the majority of the terms

and provisions will be found in the loan agreement.

However, a construction loan will also have construction-

specific guaranties, such as the carry guaranty and

completion guaranty. For a form of loan agreement that

can be modified for use in Florida, see Construction

Loan Agreement. For forms of guaranties, see Guaranty

Agreement (Construction Obligations) and Guaranty

Agreement (Repayment Obligations) (Construction Loan).

Additionally, as part of the construction loan documents, a

certificate and consent of each of the general contractor,

architect, and engineers will be required. These certificates

and consents, among confirming various project items, are

issued by each of the general contractor, architect, and

various project engineers to confirm that these parties will

adhere by certain construction loan agreement provisions

(e.g., such as restrictions on change orders, their contracts,

or the plans and specifications of the project), will govern

the priority of the contracts in relation to the loan, and

will outline the procedure for continuing construction of

the project between lender and the relevant party after an

event of default by borrower under the construction loan.

For forms of certificates and consents, see Certificate of

Architect, General Contractor’s Certificate, and Consent of

General Contractor.

There will also be assignments of permits, contracts,

developer rights, any development agreement, and any

such other items that would permit the lender to step into

the shoes of the borrower in the event that the lender,

most times after an event of default, has decided to

proceed with the construction of the project. For a form

of assignment, see Assignment of Contracts, Licenses, and

Permits (Construction Loan). For more on development

agreements, see Construction Loan Agreements —

The Developer and the Development Agreement in

a Construction Loan. For a form of assignment of

development agreement, see Collateral Assignment of

Development Agreement.

Construction Loan Diligence

Similar to the loan documentation, the baseline loan

diligence in a Florida construction loan transaction will

be the same as would be conducted in a mortgage loan

transaction. As a caveat to the lender’s title policy that

will be issued after closing of the construction loan, the

lender will want construction loan advance endorsements at

the time of each draw. A construction services agreement

between the lender, borrower, and title company is usually

also entered into at closing as part of the title diligence on

the loan.

Construction diligence will include receiving and reviewing,

in part by counsel and in part by the lender and lender’s

inspector:

• The general contractor’s construction contract

• Architect contracts

• Engineer contracts

• The development agreement

• Subcontractor contracts

• Plans and specifications

• Permits

• All land use and zoning approvals and entitlements for

the project –and–

• All other diligence required by the lender or its inspector

for them to review the project and the budget

In addition to the land use and zoning approvals and

entitlements, a lender may also require a zoning opinion

confirming to the lender, among other items, that the

project is or will be properly permitted and is feasible

pursuant to applicable zoning laws.

In addition, prior to closing and during the loan diligence

stage, the lender’s inspector will be retained and conduct

a plan and cost review prior to closing that will confirm to

the lender various items that impact the project, including

the feasibility of the project in light of the plans and

specifications and the budget, the risk of cost overruns,

the reputation of the contractor and reliability based on

prior experience, potential disruptions that could impact

project completion, and reliability of the budget and other

estimates. The plan and cost review is a critical component

of a construction loan and is used by lenders to mitigate

their risk in construction loans. While the lender’s counsel

does not generally review the plan and cost review report,

it is important to understand the overall concept and

importance of this report.

For further guidance on performing diligence in a

construction loan transaction, see Due Diligence in

Construction Lending.

Lender Considerations

As a lawyer representing a lender in a construction loan,

it is important not only to understand the concepts

discussed in this practice note, but also to have sensitivity

to the following items that are important to the lender’s

perspective:

• The project should be well-defined in the loan

documents, you should have a clear legal description,

title and survey should be aligned, and you should have

a building footprint overlaid on your survey to ensure no

issues. You will also want to know how far from approval

of the project and permitting the project is and whether

that works with the maturity date and timeline for the

project if the loan is closing prior to permits being issued.

• The notice of commencement should comply with

Florida Statute and you will want to control recording of

same. Ideally, the closing agent will record the notice of

commencement after the mortgage on the closing date.

You will want to prepare the notice of commencement;

ensure the project, borrower, and lender information

is correct; and complete and attach any payment and

performance bonds as required.

• Lenders will want to limit changes to the general

contractor, architect, and engineering contracts; the

budget; the plans and specifications; and all project

timelines. It is important to have provisions in the

construction loan agreement that flesh out what changes

require lender consent and which, if any, do not and

for those limitations and restrictions to be included

in the certificate and consent signed by the relevant

construction parties so that all are aligned on the

construction loan restrictions and where lender consent is

required.

• The material adverse effect provisions in the loan

agreement should include, depending on lender

preference, items such as ability of the borrower to

construct the project, ability to attain completion by the

maturity date (or any earlier date), and ability to comply

with the construction covenants in the loan agreement.

• The lender may want the right to step into the

borrower’s shoes and construct the project prior to

an event of default or at any time after one, whether

directly or by enforcing the completion guaranty. Some

lenders prefer broad rights to take over construction if

they feel that completion is not likely, even if an event of

default has not yet occurred.

Borrower Considerations

In turn, on a borrower representation in a construction loan,

some items to note are as follows:

• Borrowers will generally push for flexibility in the

construction loan agreement, which unsurprisingly

is contrary to what the lenders would prefer. Most

borrowers will want a monetary threshold of permitted

change orders that do not require lender consent, the

ability to adjust the plans and specifications (perhaps to

allow for flexibility in future negotiations with potential

tenants and owners), the ability to reallocate costs

savings between line items in the budget, and the right

to use force majeure or other such permitting delays to

roll their completion deadline. Lenders usually are willing

to agree to some thresholds of these items in amounts

or as to items that they would not deem material. For

example, small changes to the plans and specifications

would likely be an item a lender would concede, but

structural changes to the plans and specifications would

likely not be conceded. Borrowers will also at times

ask for flexibility with retainage requirements and may

even ask that the equity requirement be staggered (i.e.,

it is put up in stages with lender funding from the loan

in between those stages as certain equity amounts

are put in by the borrower). As borrower counsel, it is

important to discuss these items with the borrower and

understand the general items that the borrower will need

or want to have a successful project. For example, if the

permits have not been issued and you are closing the

construction loan before the relevant permits are issued,

what permitting delays can be foreseen that you will

want to work around in the completion timeline in the

loan agreement? Thinking through the key components

of a construction loan as noted in this practice note will

help identify areas that you need to discuss with the

borrower to ensure that you negotiate as much flexibility

as possible.

• Borrowers will also want to make sure that they have

a force majeure provision in the construction loan

agreement and that it is broad, even at times covering

items such as permitting delays. Post pandemic, some

borrowers are negotiating governmental closures,

unavailability of materials, and large increases in costs

to materials (whether by deeming a monetary threshold

or percentage) as force majeure to protect them from

being in default due to items that are out of their control.

As can be expected, lenders will want to limit what is

included in this definition and borrowers will want to

expand the provision. A fair compromise can be found

by tying thresholds to certain items where feasible

and negotiating time limits for certain events. If notice

is required for a force majeure event to take effect,

borrowers will want to ensure that they understand the

notice requirements fully.

• As with most loans, borrowers will want notice and right

to cure. This will be important in the context of defaults

that are related to the project and its construction.

Borrowers will always want the right to bond off liens

and solve any contractor or subcontractor disputes

without those disputes triggering a default as long as

they are working towards resolution.

• As can be expected, borrowers will want to negotiate

limitations on their lender taking over construction of

the project. As borrower’s counsel, you will want to try

to negotiate notice, right to cure, and even perhaps a

guarantor taking over prior to the lender being able to

do so to give the borrower the ability to complete the

project if it can do so. A guarantor completing the project

if for some reason the borrower cannot is a good default

provision for the borrower, and while not the ideal for

either of borrower or lender, if it can be a cure that is

successful, is a good avenue to be explored by the

parties.

Conclusion

This practice note summarizes the key elements of a

Florida construction loan. For lawyers that have experience

with mortgage loans, a construction loan layers on that

experience. In sum, a basic understanding of these concepts

is the first step in representing a client in a construction

loan transaction in Florida. At the forefront of that analysis

is reviewing these concepts in light of the role of the

representation (whether lender or borrower side) and, as

discussed throughout this note, knowing how those key

concepts and elements impact the client and what the

client’s goals and risk concerns are in such a representation.

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Elena Otero, Partner, Holland & Knight LLP

Elena Otero is a transactional attorney in Holland & Knight’s Miami office primarily practicing in the areas of real estate, finance, and banking

law, with a focus on commercial real estate and commercial lending transactions. Ms. Otero counsels local, national, and international

financial institutions and lenders in commercial lending transactions, including construction and permanent real estate financing, healthcare

real estate finance, commercial and industrial loans, and asset-based lending. She also represents clients in the acquisition, development,

leasing (including sale-leaseback, triple-net and build-to-suit lease transactions), disposition and financing of commercial and residential real

estate.

Ms. Otero’s experience advising developers includes representation in various types of projects such as land development, condominiums,

mixed-use developments, joint venture investments, hotels, restaurants, retail, and office buildings. Additionally, that representation usually

involves navigating contractual, zoning, and other developmental issues that arise as project development evolves. She also assists clients

with management of real estate assets and a multitude of contractual agreements, including subleases, licenses, and assignment agreements.

Additionally, Ms. Otero works closely with the firm’s estate and tax planning team to counsel wealthy individuals, their families and their

businesses in their real estate investments, acquisitions, and dispositions. Ms. Otero also represents institutional and private lending clients

with licensing, regulatory and compliance matters.