Avoiding "Lender Liability" When Nonprofits Make Home Repair Loans The Challenge of Making Home Repair Loans.
Home repair loans to low income owners are difficult. Home owners can't
usually find good contractors. Why would a reputable contractor want to do a
low profit - high risk deal (once you start a rehab project who knows what kind of
unforeseen problems you will encounter - "you don't know what you'll find behind
the wall", etc.). 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
The Root Cause of the Problem - Muddled Relationships
The first step in staying out of trouble is for the Lender to have a
in the back of its mind of the precise nature of the relationships
between the parties.
The a diagram below outlines the legal relationships between the
the Contractor retained to do repairs or rehabilitation, and the Lender.
The Lender's legal relationship is with the Borrower and not the
Contractors legal relationship is with its customer, the homeowner, and
A Trap for Lenders:
Borrowers typically are inexperienced in dealing with Contractors.
therefore, often see a need to take it upon themselves to try and help
with tasks such as bidding, contract execution, negotiating change
orders, and directly
supervising the contractor.
Such involvement in the "business" of the Borrower, however, exposes
Lender to potential liability whenever there is a dispute between
the Borrower (which is often). "Lender
is an emerging area of the law.
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
not fully acceptable to the Borrower. Thus when the Contractor fails to
do the work
properly the Bor rower may point his or her finger at Lender as the
party (essentially, a claim that the Lender was negligent in performing
duties it had undertaken).
Contractors, on the other hand, sometimes might get the
wrong impression that
the Lender is a party to their agreement with the homeowner or the
Thus when the Borrower refused to authorize a draw request on account
work, the Contractor might start making demands upon the Lender.
The Lender's Goal: To immunize the itself (as
much as possible) from these
types of claims.
Recommendations: "Tighter" Contracts and Lender Inner
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.
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.
description of the specific work to be done by the Contractor
would be described in 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.
"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.
contract would require that the Contractor submit all of its invoices
directly to the Borrower (its customer) and not to the Lender.
contract would specify that the Lender will disburse only upon the
a payment request (on a form proscribed by the Lender) had been signed
and submitted by the Borrower with the Contractor's invoice attached.
the payment would be made only if the Lender, after inspection was
reasonably satisfied that the work had been properly done.
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
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).