Financing for construction projects is a common point of contention because in most cases, financing is borrowed and repaid after the completion of a construction project. Understandably, when a lender gives money to an owner, they want to be absolutely certain that they will be reimbursed. Secured lending occurs when a contract is established between a borrower and lender. A lender can be an individual, a financial institution, or a trust organization.
In this two-part article, the construction law experts at Cotney Construction Law will discuss secured loans with bonds, note, and mortgages. If you are a contractor in need of a trusted legal professional to assist you with contract review, bond law, or lien law, contact a West Palm construction lawyer today.
Bonds, Notes, and Mortgages
Notes and mortgages are two examples of formal contracts established between financial institutions and owners to help fund construction projects. As a rule of thumb, the cost and deadlines associated with repayment are clearly documented in the loan agreement.
Public construction projects are commonly financed by bond issues directed at a single project or groups of projects. A trust company is assigned to represent an array of individual bondholders for publicly issued bonds to avoid repayment issues.
Certainly, borrowed funds present a risk to both the borrower and the lender, so borrowed funds are typically secured by forfeiting certain rights to the construction project, or another comparable asset, to protect the lender from an owner who defaults on required payments.
Conversely, corporate bonds like debentures can take the place of loans secured exclusively by good faith and the credit history of the borrower.
Rights of the Bondholder
Traditionally, the borrower can reserve the right to repurchase the bonds multiple times as long as the agreement has not reached the maturity date. If a borrower wishes to do this, they must repay the principal and any interest due at the time of repurchase; otherwise, they risk violating the bond agreement. The bondholder can also trade a bond on the secondary market, but fluctuating interest rates can lead to a loss of value on a bond.
Determining the value of a bond can be tricky because the actual value of a bond considers the market discount or premium paid in relation to the face value. Alternatively, you can assess the yield to maturity or internal rate of return on the bond to help indicate its true value. The yield to maturity can be calculated by determining the interest rate that establishes the (discounted) future cash flow of a bond equivalent to the active market price.
In part two, we will examine several other elements of evaluating bond values as well as other features of borrowing agreements.
Disclaimer: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.