When the Bank Doesn't Pay

Everyone relies upon construction loans. Owners, contractors, subcontractors and suppliers rely upon the lenders (usually a bank) for payments needed for construction. The loans are made to the owner, with periodic disbursements, usually monthly, after the bank is satisfied work is progressing on an agreed upon schedule. Work and materials are provided in advance of payments, with the understanding that the bank will make payments as the work progresses.

But what happens when work and materials are provided and the bank refuses to pay? Does the contractor, subcontractor or supplier who provided labor and materials have any right to demand payment from the bank? The answer in New Jersey is no. New Jersey courts have found that unless the bank has entered into a written agreement with a contractor, subcontractor or supplier, the bank is not liable, and the contractor, subcontractor and supplier takes the loss if the owner cannot pay.

I recently tried a case where a design-builder entered into a contract with an owner to design and build a tennis center. My client prepared a budget and design, and both were submitted to the bank for approval. The bank approved both, and provided a construction loan to the owner. The loan documents specifically named my client as the design-builder. My client knew the loan was made and relied upon the bank to make payments for labor and materials provided to the project.

Although the bank made the first three payments, it refused to make any further payments. My client was left without payment for materials and labor in an amount totaling $244,000.

The owner subsequently filed for bankruptcy protection, and the property was sold through the bankruptcy court, leaving my client without a remedy against the owner.

In our suit against the bank, we argued the bank had a responsibility to pay my client since my client relied upon the bank to make payment, the bank knew of this reliance, and all of the facts and circumstances made it clear my client was a third party beneficiary of the construction loan agreement.

The court found the bank had no responsibility to my client and only owed an obligation to its customer, the owner. This ruling left my client without any remedy for payment for the work and materials it provided to the project.

I therefore strongly recommend that if you are in a similar situation, that you seek and obtain a written agreement from the construction loan lender that you will be paid by the lender for the work and labor you provided, even if payment is not made by the owner.