Construction Law - Brian J. Morrissey

• Publication year: 1994

Construction Lawby Brian J. Morrissey^*

I. Introduction

As the construction industry moved through its recession, a number of issues eventually percolated their way through the appellate courts. Not surprisingly, once projects began going under, many of these cases focused on novel theories seeking to impose liability against "deep pockets."

The most significant event during the survey period was the development of a unique approach to impose liability against the government for the insolvency of sureties presented on public works projects, and the abrupt reversal of the adoption of this theory by the Georgia Supreme Court.

Also during the survey period, there were a number of attempts to impose liability against lenders on construction projects for the failure to ensure that payments were made to contractors in such a way as to avoid the imposition of liens, and on commitments to keep construction loans flowing.

II. Lender Responsibilities and Rights

The entanglement of the banking industry in both commercial and residential construction raised a number of issues concerning a lender's responsibilities and rights vis-a-vis the participants in a construction project. As a lender moves toward "pulling the plug" on a particular project or development, the ramifications for an owner or a contractor may be extremely serious and detrimental. Borrowers and third parties affected by a lender's actions have all sought, through various means, recourse against a lender who acts in a manner detrimental to the furtherance of a project. Georgia courts have always been reluctant to place a great deal of responsibility on lenders in connection with their actions concerning loans. However, the degree of involvement by a lender in a particular project or development may be the key factual feature affecting a determination of a lender's responsibilities.

A. Disbursement of Loan Proceeds

Typically, a lender has no liability beyond its contractual responsibilities to the parties with whom it contracted.¹ This principle was followed during the survey period. In Peterson v. First Clayton Bank & Trust Co. ,² Stovall Building Supplies, a supplier of materials used in the construction of a house, filed a complaint to foreclose a materialman's lien against the owner and to collect on an open account against the builder, Shope, in connection with the construction of a house for Robert and Gertrude Peterson, the property owners.³ The Petersons filed a third party claim against the construction lender, First Clayton Bank & Trust, alleging that the bank breached its contractual and fiduciary duties in disbursing loan proceeds for the construction of the house.⁴ The Petersons' main allegation against the bank was that it failed to administer and account for disbursements properly, and it failed to exercise appropriate care in assuring that the builder had been paying subcontractors and suppliers.⁵

The construction contract between the Petersons and the builder required the builder, upon request, to furnish the owner or a bank representative with times of withdrawals. Furthermore, the builder would have to provide a statement showing an itemization of expenditures to date, items due and unpaid, and supporting documentation including receipts, as well as affidavits, waivers of liens, and other evidence of payment. After reviewing the construction contract, the bank agreed to finance construction of the house.⁶ During a series of conversations, it became clear that the bank, as part of its loan function, would handle disbursements and payments to the builder required under the construction contract.⁷ Also, the bank would regularly inspect the property to monitor progress of the construction.⁸ The Petersons, who were living in Florida at the time, could not monitor the progress of their home's construction in Georgia.⁹

The Construction Loan Agreement between the Petersons and the bank stated:

Borrower authorizes and directs Lender to pay any loan proceeds due under the terms of this agreement to [the builder]. Lender has no liability or obligation in connection with the project or the construction and completion thereof, except to advance loan proceeds as agreed in this document. Lender is not obligated to inspect any improvements, nor is it liable for the performance or default of any contractor or subcontractor or for any failure to construct, complete, protect, or insure said improvements or for the payment of any costs or expenses incurred in the project. Nothing, including without limitation any disbursement or the delivery or acceptance of any document or instrument, shall be construed as a representation or warranty on Lender's part. Lender is not the agent or representative of the Borrower, and the Borrower is not the agent or representative of the Lender. This agreement does not reflect a partnership or joint venture on the part of the parties and shall only serve to represent and document the loan in terms of Borrower's construction loan .... Lender reserves the right to require execution of any materialmen's lien affidavits or release of materialmen's lien affidavits by any contractor or subcontractor or Borrower at any time during the term of this agreement .... The parties agree that the Lender may disburse the proceeds of the loan to pay any expenses or liens incurred in connection with the construction and completion of the single-family residence and payment or performance of any obligation of Borrower to Lender, and at its election, Lender may pay said proceeds to Borrower or to the contractor or to any other person furnishing labor, supplies or services for construction of the residence or to the holder of any lien, charge or encumbrance on the premises or other property securing the loan, and the whole of such proceeds are hereby assigned, transferred and pledged to Lender for such purposes .... This agreement shall constitute the sole agreement between the parties and shall not be modified, changed or altered unless in writing executed by both parties.¹⁰

Simultaneously, the Petersons signed an agreement authorizing a bank official to handle disbursements of draws payable directly to the contractor on the construction loan.¹¹

The bank proceeded to disburse funds to the builder upon request, sometimes with the participation of the Petersons, who at times reviewed disbursement requests. The builder failed to pay suppliers and subcontractors, however, and as a result, $38,000 in liens were filed against the property, which were not satisfied by the Petersons. The Petersons defaulted on the Construction Loan Agreement by failing to remove the liens, and the bank foreclosed on the property.¹²

The bank moved for summary judgment on the Petersons' third party claim for negligence and breach of fiduciary duty.¹³ The trial court granted the bank's motion, and the Petersons appealed.¹⁴ The Georgia Court of Appeals found that the bank had not undertaken any responsibility to ensure that materialmen and subcontractors were paid before disbursing loan proceeds to the builder.¹⁵ In doing so, the court of appeals rejected the Petersons' argument that the agreement by the bank officials to make such payments was a modification to the terms of the Construction Loan Agreement.¹⁶ There was no modification because the bank officials did not promise anything other than what the Construction Loan Agreement provided for in the first place, that is, that the bank could disburse payments directly to the builder and would monitor construction progress.¹⁷ No implied contractual provision existed since an obligation to ensure that materialmen and subcontractors were paid was not necessary to effect the full purpose of the contract between the Petersons and the bank; therefore, it could not fairly be said to be within the contemplation of the parties.¹⁸ The Petersons expressly authorized the bank to pay loan proceeds directly to the builder, and the Construction Loan Agreement provided that the bank was not liable or obligated in connection with the project in any respect except to advance loan proceeds as agreed in the contract.¹⁹ Thus, no implied contract could exist simultaneously with this express understanding.²⁰ Regarding the Petersons' claim for negligence and breach of fiduciary duty on the part of the bank, the court of appeals held that in addition to any breach of contractual obligation, there must also be a breach of a duty imposed by statute or recognized legal principle.²¹ Typically, a lender has no obligation to protect the owner on a construction project unless the lender's activities extend beyond that of the conventional construction lender and the lender actually engages in activities connected to the construction of the property.²² The court of appeals found that the bank, while agreeing to assist the Petersons by making payments directly to the builder, did not agree to obtain lien waivers, payment affidavits, or otherwise ensure that suppliers were paid before disbursing funds to the builder.²³ Moreover, the Petersons did not surrender to the bank their own contractual obligations to ensure that all labor and material bills were paid and that the property be kept free from liens.²⁴ The court of appeals concluded that the bank's primary role was to protect its interests in the secured property and not to ensure that the borrowers' interests were protected.²⁵ While the bank had an obligation to exercise diligence and good faith in the disbursement of construction funds in a timely manner for work actually performed, nothing in this obligation compelled the bank to undertake duties owed by the builder or the Petersons.²⁶

B. Continued Availability of Credit

In Wachovia Bank of Georgia v. Mothershed,²⁷ Wachovia Bank's motion for summary judgment was granted on its claim for a deficiency judgment on three promissory notes made as construction loans to Mothershed.²⁸ Mothershed counterclaimed for breach of an oral contract under...