Canadian lenders and banks with U.S. subsidiaries routinely engage in cross-border construction financing for real property projects located in New York. Typically, these loans are structured to manage the cross-border nature of the transaction by utilizing the borrowers’ U.S.-based affiliates or subsidiaries to grant the mortgage and security interest in the real property and improvements located in New York. Similar to U.S.-based lenders, Canadian lenders often require experience, strong liquidity, and market feasibility studies, as well as detailed construction timelines and contracts. For these transactions, Canadian lenders will require New York law-governed mortgages and other security documents for the borrowers’ U.S. entities, in addition to the documents governed by Canadian Law. It is important for Canadian lenders to engage New York counsel who are fully familiar with the nuances of construction lending in the state. Failing to comply with the highly technical requirements imposed on lenders by the New York Lien Law (N.Y. Lien Law §§ 1 to 251) (the “Lien Law”) can lead to significant negative outcomes, including loss of lien priority and costly litigation.
Differences between Construction Loans and Permanent Loans and Types of Construction Loans in New York
A construction loan is a short-term interim loan used to finance the construction or renovation of real property. Among other things, the fundamental differences between a construction loan and a permanent loan are that (i) the real property collateral supporting the construction loan is not yet complete (either because the improvements on the real property do not yet exist or, alternatively, the improvements are in the process of undergoing construction or reconstruction) and (ii) a construction loan is not fully funded at the time of the closing but is advanced in stages and tranches as the construction project progresses. These differences generally make construction loans riskier for lenders than permanent loans, and that risk is further heightened in New York due to the Lien Law requirements, as discussed below. There are a variety of different types of loans utilized in commercial real estate construction financing in New York, including, but not limited to, (i) a land development loan, (ii) an acquisition and development loan, (iii) an interim construction loan, and (iv) a construction-to-permanent loan. Canadian lenders should consult with New York counsel early in the process to confirm the type of construction loan (or combination) to be used for the particular project and provide guidance on the structure.
Key Aspects of New York Lien Law for Construction Lending
Construction lending in New York is highly technical and requires strict compliance with the Lien Law. Before making a construction loan in New York, Canadian lenders and banks should consult with New York counsel to understand the requirements and obligations imposed on construction lenders under the Lien Law. The Lien Law sets out the procedures for obtaining and enforcing a mechanic’s lien in New York, and failure to comply with the strict requirements in construction lending can lead to the loss of the lender’s priority and costly litigation.
In New York, a lender making a construction loan to a borrower for improvements to real property must record a building loan mortgage and must also file: (i) a building loan agreement on or before the date the building loan mortgage is recorded, (ii) any modifications to the building loan agreement within ten (10) days of execution, (iii) a Section 22 affidavit with the building loan agreement and with each modification to the building loan agreement, and (iv) a notice of lending with the building loan agreement and, additionally, each time an advance is made under the construction loan.
Notably, the Lien Law restricts the costs and expenses that are permitted to be paid out of building loan proceeds to maintain a lender’s priority. The proceeds of a building loan may be used to pay only the “costs of improvements” to the real property, as defined in Section 2 of the Lien Law. “Costs of improvement” typically consist of (i) the hard costs of construction, such as payments to contractors, subcontractors, laborers, and materialmen and (ii) certain permissible soft costs related to the improvements, such as real estate taxes, architect, engineer and surveyor fees, lender’s legal fees and title insurance premiums, recording and filing fees for the building loan agreement and the building loan mortgage, and interest on the building loan. Although the term “cost of improvement” is defined in Section 2 of the Lien Law, determining which items in a construction loan budget qualify as a “cost of improvement” is often one of the more challenging aspects of structuring and documenting a construction loan. This determination is critical because, in New York, advancing building loan proceeds for expenses that do not constitute a “cost of improvement” results in the lender losing priority for that advance and subordinates the lender’s mortgage lien to subsequent mechanics’ liens.
Canadian Lenders - Protect Your Interests and Engage New York Counsel for Construction Financing Transactions in New York
There are many other nuances and considerations for Canadian lenders or banks involved in cross-border construction lending transactions in New York, given the technical and stringent requirements of the Lien Law and the specific facts and circumstances of the construction project. Canadian lenders or banks involved in cross-border construction lending transactions in New York should seek the advice of New York counsel to protect their interests. Doing so helps them avoid significant negative consequences arising from noncompliance with the highly technical requirements imposed on lenders by the Lien Law.
Contact our experienced Cross-Border Finance team at Hodgson Russ LLP for a review of your construction loan financing transactions in New York to ensure compliance with the Lien Law.
About the Authors
Christofer Fattey and Michael Condon are partners at Hodgson Russ LLP. They concentrate their practices on representing borrowers and lenders in secured lending, construction lending, and other transactions, with an emphasis on cross-border financings.
