Stored Materials: Finding Common Ground between Borrower and Lender

Stored materials present a potentially serious point of tension between lenders and borrowers in the negotiation of a construction loan agreement. In construction lending, the term “stored materials” refers to the materials and items that are purchased in advance of their use and incorporation into the project. Those materials will need to be stored either on the project site or in a warehouse or other location “off-site.” Many lenders are wary about allowing funds to be used for stored materials because of the risk of loss off-site and, accordingly, may place conditions on the use of such funds. However, the borrower, usually through its general contractor, needs to purchase materials “in advance” to keep construction moving smoothly. For example, it would be completely impractical to require the general contractor to purchase the windows of a high-rise on a daily, as-needed basis.

The result is often heavily negotiated stored materials provisions in loan agreements. No matter the specific provisions, it is critical that the stored materials terms included in the borrower’s construction contract with the general contractor be consistent with the stored materials terms of its loan agreement with the lender. The borrower should avoid a situation where conditions to payment for stored materials in the loan agreement go beyond those in the construction contract. Otherwise, the borrower runs the very real risk that it will owe money to the contractor for stored materials but will not be able to obtain those funds from the lender. From a cost and budgeting perspective, the general contractor often finds it advantageous to purchase materials in advance when (1) securing early competitive pricing, (2) purchasing in bulk to reduce costs, or (3) ordering items that require long procurement time or separate construction (i.e., elevators).

On the other hand, while controlling costs is in every party’s best interest, the lender may be wary of practices that do not properly protect its interest in the collateral of the project.

The Lender’s Concerns
For the lender, stored materials represent an additional risk in construction lending. First, the lender faces the tangible risk of loss. Most often, this may take the form of theft, damage or deterioration. Second, the lender faces risks in terms of legal rights over (i.e., as security interest in) the material in the event of a default by the borrower. This risk centers on the lender’s lien priority over the materials against claims from the original vendors, the storage facility or another potential third party. A lender may seek a term in that agreement that explicitly states its security interest over stored materials, such as “Lender has or will have upon payment with disbursed funds a perfected, first priority security interest in the stored materials.” To safeguard its interest, the lender may impose restrictions on the storage of materials or control the use of loan disbursements. Some examples of lender-friendly terms regarding stored materials include:

• Proof of insurance on stored materials against casualty, inclement weather and theft, including in some cases the naming of the lender as beneficiary under the policy
• Prohibitions on any vendor liens over stored materials
• Evidence that satisfactory measures are being taken to protect against theft, casualty, or deterioration
• Proof of borrower’s ownership and title over the materials
• Logs of stored materials or, in extreme cases, weekly pictures of the materials showing their current condition and storage
• Storage of all off-site materials in a bonded warehouse without any commingling of the borrower’s stored materials for other projects or any other materials within the warehouse
• Production of specific information such that the loan consultant can confirm the location and condition of all stored materials at any given time
• Limits on the maximum number of days that materials can be stored between purchase and incorporation into the project
• Caps on the total aggregate value of materials in storage at any given time

The Borrower’s Concerns
For the borrower, and by extension its contractor, the issues surrounding stored materials are those of logistics and budgeting. The borrower is responsible for managing the flow of funds from the lender to the general contractor, and the borrower would like the general contractor to be able to purchase materials in a manner that is the most efficient at the least cost. Thus, the borrower will seek to maximize the flexibility in funding and minimize the requirements around storage. This can allow the general contractor to lock in advantageous pricing where available and reduce costs on large, specialty or complex components. Accordingly, the borrower will have two goals: (1) to narrow the types of materials to which restrictions apply and (2) to minimize the number of restrictions.

Some borrower-friendly terms that narrow the scope of restriction include:

• Setting a minimum aggregate value of stored materials before restrictions on their purchase apply
• Excluding materials stored on the project site

Some borrower-friendly terms regarding the restrictions include:

• Requiring only reasonable insurance and title guarantees
• Setting only reasonable limits on the time by which stored materials must be incorporated into the construction work
• Not imposing onerous burdens on storing and monitoring of materials
• Setting reasonable caps that limit the amount of stored materials outstanding at any one time
• Allowing specific exceptions to the general rules for unique and large components of the project

Stored materials represent an issue that is extremely project specific, and the opposing interests of the lender and general contractor can lead the relevant loan provisions to be heavily negotiated. Finding common ground between a lender’s need to ensure that disbursements are used on secure items that contribute immediately to the loan collateral and a borrower’s need for consistent terms between the loan agreement and the construction contract often requires both parties to come together at the negotiating table. There, they can reach a tailored arrangement that fits the unique needs of the project and the interests of the parties involved.