Construction Law

Nov 192012

Oral Modification to Construction Contracts

Construction contracts typically contain provisions that explicitly require the parties to reduce all modifications to the contract into writing. These “additional work” provisions are written to prevent the enforceability of oral modifications to the contract and, hopefully, prevent both parties from a potential loss. However, the Tennessee Court of Appeals recently allowed the parties to modify a construction contract by oral agreement even though the original contract explicitly required modifications to be in writing.

In Song & Song Corporation, and Jin Y. “Jim” Song, Individually v. Fine Art Construction Company, LLC, et al., No. W2011-01708-COA-R3-CV (Tenn. Ct. App. June 14, 2012), a property owner hired a general contractor to perform construction work on a commercial building. The contractor later performed additional work deemed necessary to install missing fire dampers without written authorization from the property owner to do so. When the work on the building was completed, the property owner refused to pay for the additional work pertaining to the fire dampers and the contractor sued.

The property owner argued that the lack of a written change order allowed him to avoid his obligations here as the contract included the following provision: “[T]his Agreement may not be modified except by separate written instrument executed by Owner and Contractor.” The Court of Appeals disagreed and found that the parties had in fact orally agreed for the contractor to perform the additional work, said oral agreements were valid and enforceable, and the property owner could not avoid his obligations thereunder simply because of the lack of an additional signed writing. The contractor was awarded full payment for the additional work despite the absence of written authorization.

Tennessee courts generally follow the rule that allows contracts to be orally modified even if the contracts specifically state that the contract can only be modified in writing. Even where the written contract prohibits oral modifications of the agreement, oral alterations will still be given effect by the Courts if otherwise valid. Regardless, contractors are still advised to document “additional work” agreements, utilize change orders, and adhere to the provisions of a construction contract to avoid future payment disputes.

Jul 302012

Construction Loan Agreements: Unless Agreed To, Lender Has No Duty To Protect Borrower’s Interests

The risk involved with a construction loan makes it very unattractive for most lenders. Nonetheless, commercial banks are drawn to construction loans because it allows them to maintain their liquidity. When the provisions of a construction loan agreement are negotiated, the bank will traditionally request monitoring systems for the disbursed funds to minimize the risk it assumes with the loan.

The general rule in Tennessee is that, in the absence of a contrary agreement between the parties, a lender owes no duty to a borrower to disburse the loan proceeds for the borrower’s benefit. This means that a lender has no affirmative duty to protect the borrower’s interests. However, as an exception to this rule the lender may assume such a duty by agreement.

In Suzich v. Booker, et al. (affirmed on Friday, July 27, 2012), a $1.7 million construction loan was exhausted prior to the completion of the borrowers’ residence. As a result, a contractor filed his claim for a materialmen’s lien for $95,000 and subsequently sued the borrowers and the lender, First Citizens National Bank, to enforce same. The borrowers responded with a cross complaint against the lender alleging that the lender breached the construction loan agreement when it disbursed all of the loan funds without inspecting the progress of the construction. The lender responded that it did not have a contractual duty to inspect the construction of the residence.

After reviewing the provisions of the construction loan agreement, the Court of Appeals agreed with the lender. In looking at the entire contract, the Court reasoned that while the lender was entitled to demand an inspection before disbursing funds to the borrowers, it was “not obligated to inspect . . . or inform [the borrowers] about the Project’s progress or performance.” Thus, the construction loan agreement did not explicitly require the lender to assume an affirmative duty to protect the borrowers’ interests.

The decision of the Court hinged on its interpretation of several provisions of the construction loan agreement. This is why all of the provisions in a construction loan agreement are important to both lender’s counsel and borrower’s counsel.