Lien-Free Conditions to Reserve Disbursements Clauses
(Construction Loan Agreement) (Pro-Lender)

Summary

These clauses are for use in a loan agreement to protect the lien of a mortgage and its priority when loan proceeds are disbursed from a reserve account while the real property undergoes construction or renovation. These clauses include practical guidance and drafting notes. When financing a construction or renovation project, a lender will often advance only a portion of loan proceeds (or, in some instances, no loan proceeds) to the borrower at closing. The lender will hold the undisbursed funds in a reserve account established at closing. During the course of construction, the lender will disburse loan proceeds to the borrower in installments upon the borrower's request and/or once the borrower achieves certain milestones in the construction process. Prior to each advance of loan proceeds, the lender must ensure that the lien of its mortgage on the property is fully protected, and that no other liens have been placed on the real property as a result of the ongoing construction or otherwise. Lien priority is of particular concern to lenders in the construction context because parties performing labor or services or providing materials for improvements at the property may be entitled to file mechanic's liens that prime the lien of a mortgage. Tax liens also have the potential to prime the lien of a mortgage. As a result, before advancing funds, the lender must ensure that various lien-free conditions precedent are met to the satisfaction of the lender and the title company. Construction loan agreements often divide disbursement conditions into the following categories: • Conditions to the initial advance • Conditions to subsequent advances • Conditions to the final advance • Conditions to each advance The drafting notes below indicate when to use the corresponding clauses. The conditions set forth in these clauses serve to protect the lender's lien in three primary ways: (1) gathering information, through title bring-downs and lien and judgment searches, to determine if any other liens have been filed; (2) requiring the borrower to discharge all such liens that appear, other than those expressly permitted by the lender; and (3) protecting the lien of the mortgage and its priority with title endorsements, lien waivers, and ongoing borrower obligations. These clauses are drafted from the perspective of the lender and contain negotiating tips for the borrower. Conform the capitalized terms and section references used in these clauses to the relevant construction loan agreement. Note that these clauses focus on lien-free completion requirements. When representing a lender, you should ensure that the construction loan agreement contains additional customary conditions precedent to loan disbursements, including financial covenant compliance, delivery of financial statements, delivery of organizational documents, satisfactory appraisals, satisfactory environmental reports, and zoning compliance. For further information on customary conditions precedent for construction loans, see Construction Loan Agreement. For further information on mechanic's liens, see Mechanic's Lien Resource Kit.