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March | April | 2015 CCIM.com
borrower f exibility. Sof cost contingencies
are for overruns from expenses such as fees
for architects and engineers, building permits,
and utility access; real estate taxes; leasing
commissions; and sales and marketing costs.
Even with reallocations of line item sav-
ings and contingencies, it is always possible
that change orders or erroneous budget
assumptions create concern that the undis-
bursed loan proceeds will not be suf cient
to complete the project and pay of the bor-
rower's obligations. If that occurs, a lender
relies on the right to declare a loan "out of
balance." Ef ectively, the lender can declare
a default based on its conclusion that the
undisbursed loan will not be suf cient to
complete the project.
An ideal loan-in-balance provision pro-
vides that the loan shall be in balance only
when the available source of funds equals
or exceeds the lender's estimate of remain-
ing costs (a global budget analysis) and each
budget line item is suf cient to pay the costs
of the line item (a line item analysis).
Because the lender needs to rely on f rm,
defensible criteria before asserting that a
loan is out of balance, the available source
of funds should incorporate the remaining
unfunded loan, the unfunded contingencies
— to the extent available — upgrade deposits,
tax deposits, and any other sources of funds
for the borrower. T e def nition of "lender's
estimate of remaining costs" should contain
objective criteria that a reasonable lender
may rely on to determine what remains
unpaid. Suggested factors include pending
and expected change orders, contractor or
supplier claims for additional amounts, and
the ef ect of anticipated or actual delays.
A declaration of out-of-balance default
allows a lender to institute default rate interest
and stop funding. Such remedies clearly cre-
ate a make-or-break situation for a borrower/
developer. T e lender must be in a fully defen-
sible position by having objective evidence if
it seeks to declare an out-of-balance default.
Developers and lenders are aligned in the
goal of a successful project delivered on time
and within budget. Reasonable approval
rights account for the evolving nature of a
construction loan. A well-developed budget
and objective criteria governing its use pro-
vide for the possibility that a complex plan
does not proceed exactly as the original bud-
get anticipated.
Joel C. Solomon is Of Counsel at Foley and
Lardner LLP where he focuses on real estate.
Contact him at jsolomon@foley.com.
A declaration of out-of-balance default allows
a lender to institute default rate interest and
stop funding.