A ruling that Citigroup Inc. must resume lending to a stalled Syracuse, N.Y., mall project could push banks to revisit how they draft construction-loan agreements.
The New York State Supreme Court Appellate Division, in a split decision, upheld an lower court’s injunction requiring Citigroup to continue funding a $155 million construction loan on the Destiny USA Holdings project, even though the bank believes the project is a failure. Citi says the ruling is unprecedented in the state’s history. Now, New York lawyers are pondering how to write construction loans that would allow banks to stop funding what they believe are failing projects.
The ruling isn’t a total victory for Robert Congel, the developer behind Destiny. The court required the company to post a $15 million bond before Citi has to fund the rest of the money, roughly $29 million.
This ruling definitely puts further strain on the market for construction financing. Lenders are willing to take a bit of risk if the yield is right and it is clear that they have the option to back out of their commitment if the developer does not live up to his end of the deal. But I can’t think of a single lender who would walk into a risky financing—no matter how high the yield is—if they cannot be certain on whether or not they have the right to back out when the developer fails to perform. NY State Supreme Court’s decision in this case does nothing to provide that certainty. Until lenders and their counsel can figure out a way to build that certainty back into their lending agreements, we can say goodbye to ground-up construction financing.
Commercial real estate lending might not be the only casualty of court rulings:
[R]ecent court decisions demonstrate how courts can override the words and intent of loan documents and lenders’ remedies notwithstanding the widespread concern about the fiscal health of our lending institutions and the need for them to recover to unfreeze the credit markets and permit economic growth to resume. The media regularly contains stories about home owners who have been able to avoid foreclosure and have their debt canceled because of administrative or technical errors by the lenders. One would think that the courts believe that the money people borrowed to buy homes magically appeared and did not come from other people’s savings, investments and retirement accounts. Has any court considered that, when they preclude a bank from foreclosing a mortgage, the home owner, who actually borrowed the money and is refusing to repay, is actually stealing the savings of their neighbors? So far, the courts seem to believe that they are playing the role of Robin Hood and ignoring creditors’ rights. This behavior is also causing lenders to think twice before making loans.
Can you say "unintended consequences"?
