Avoiding "lender Liability"
When Nonprofits Make Home Repair Loans
CLICK HERE for a handbook on operating government funded home repair lending programs
The Challenge of Making Home Repair Loans.
Home
repair loans to low income owners are difficult. First of all, its hard
to find a good contractor. Why would a reputable contractor want to do
a low profit - high risk deal. Many of the contractors who bid on these
type of projects turn out to be incompetent and dishonest. Low income
homeowners have difficulty properly managing contractors after they
have been retained (regardless of whether they are good or bad).
The Root Cause of the Problem - Muddled Relationships
The first step in staying out of trouble is for the
lender to have a clear understanding of the relationships between the
parties. The diagram below outlines the legal relationships between the
homeowner ("borrower"), the contractor, and the lender.
The
nonprofit lender's legal relationship is with the borrower and NOT the
contractor. The contractors legal relationship is with its customer,
the homeowner, and NOT the lender
.
A Trap for Nonprofit lenders:
Borrowers typically are inexperienced in dealing with contractors.
Nonprofit lenders, therefore, often see a need to take it upon
themselves to try and help their borrowers with tasks such as bidding,
contract execution, negotiating change orders, and directly supervising
the contractor
.
The Risk:
Such involvement in the "business" of the borrower, however, exposes
the lender to potential liability whenever there is a dispute between
contractor and the borrower (which is often). The concept of "lender
Liability" is an emerging area of the law. It is safer for lenders not
to try and micromanage the behavior of the contractor
If the lender is not careful
the borrower might be led to believe that the lender was supervising the work
of the contractor and/or making disbursement decisions not fully
acceptable to the borrower. Thus when the contractor fails to do the
work properly the borrower may point his or her finger at lender as the
alleged guilty party (essentially, a claim that the lender was
negligent in performing the supervision duties it had undertaken).
Contractors, on the other hand, sometimes might get the wrong impression that the lender is the homeowner's agent agent.
Thus when the borrower refused to authorize a draw request on account
of shoddy work, the contractor might start making demands upon the
lender.
The lender's Goal: To immunize itself (as much as possible) from these types of claims.
Recommendations: "Tighter" Contracts and lender Inner
Discipline
Gaining an Accurate and Detailed Understanding of the Work to Be Done:
The lender should inspect the house prior to making a loan commitment
and prepare a detailed write-up itemizing the work that needs to be
done and the estimated cost.
Contractor's Agreement:
The lender should never negotiate directly with the contractor on the
borrower's behalf. The lender should seek to control the contractor's
behavior by controlling the flow of money. The loan commitment to the
borrower should make it a pre-condition to lending that the borrower
first submit to an executed agreement with the contractor that meets
the lender's reasonable satisfaction. To make compliance with this
pre-condition easier the lender might suggest that the borrower use a
particular contract form.
- A detailed description of the specific work to be done by the contractor should be included (perhaps as an attachment labeled "Scope of Work")
- Before
approving a particular contract the lender would assure itself that the
"Scope of Work" section accurately and precisely described the work
that was to be done (thus minimizing the potential for subsequent
disputes). The lender would reject proposed contracts with inadequate
descriptions of the Scope of Work.
- The "boilerplate" language of the suggested contract form would, in plain and descriptive English, describe in detail the lender's disbursement requirements, including a description of the types of information that must be included in each of the contractor's invoices to the borrower
-
The contract would require that the contractor submit all of its
invoices directly to the borrower (its customer) and not to the lender.
- The contract would specify that the lender disburse only upon the following conditions.
-
That a payment request (on a form proscribed by the lender) had been
signed and submitted by the borrower with the contractor's invoice
attached.
- That
the payment would be made only if the lender, after inspection was
reasonably satisfied that the work had been properly done.
- This
type of procedure will prevent the borrower from later complaining that
the lender paid for work that was not satisfactory to the borrower.
It will also minimize the chances that the contractor will start
sending demand letters to the lender every time a disbursement request
is rejected.
Supervision of the contractor: The lender should never act
as an intermediary to resolve disputes between the borrower and the
contractor. Instead, the lender should control the contractor's
behavior by controlling the flow of the money. The lender would approve
a loan only if the contractor's Agreement contained a detailed
description of the precise work that was to be done and an explicit
description of the lender's disbursement procedure. The borrower would
be made to understand that the lender's inspection of the work
following a disbursement request was for the lender's benefit (the
lender might even want to have the borrower to sign a separate simple
English acknowledgement of this even though the same language might
also appear in the Loan Agreement).