A Brief Introduction About the Acquisition and Construction Loan Agreement
Most people who purchase land intend to use it for a constructed property. However, they take the loans for the land first and then when they want to develop it, they enter into a construction loan agreement for construction of the property. This increases the transaction costs of borrowing loans and therefore the cost of the loan itself. Besides, because you already have one loan unpaid, the second loan that you take will bear higher rates of interest. To avoid all this hassle, an acquisition and construction loan agreement is drafted
This agreement is drafted between a lender and a borrower. This lender is usually a financial institution while the borrower might be an individual or a corporate body. The loan is taken for all the activities from acquiring until completion of the construction of the property. This ensures that there is only one loan at any given time, instead of an agreement for land acquisition and a construction loan contract
Who Is Involved in the Acquisition and Construction Loan Agreement?
This agreement, also known as an acquisition and development loan agreement, is drafted between a lender and a borrower. The borrower wants to acquire land and purchase the property. The borrower might be an individual or an institution, while the lender is usually a financial institution.
Purpose of the Acquisition and Construction Loan Agreement
The purpose of an acquisition and construction loan is to reduce the cost of a loan. In normal scenarios, two loans are taken — one for acquisition and one for construction. However, this increases the overall cost when an individual wants to develop the land into commercial property. By taking only one loan, there are a lot of benefits, many of which will be discussed below. The purpose of this acquisition-to-develop loan is to take only one single loan throughout the process of acquisition to construction.
A simple construction loan agreement can be for two major purposes
- Acquisition and commercial construction loan agreement if the construction is for commercial purposes
- Acquisition and residential construction loan agreement if the construction is for residential purposes
Contents of the Acquisition and Construction Loan Agreement
A standard Acquisition and Construction Loan Agreement template includes the following: –
- Details of all the parties involved, especially if more than one party is involved from acquisition to development
- Amount of loan sanctioned including the ceiling limit of usage
- Type of loan — whether it is revolving credit or lumpsum amount of loan
- Conditions for prepayment or early closing of the loan
- Furnishing information about previous records relevant to the loan
- Categorization of the loan into hard A&D costs and revolving costs
- Identification of rules that govern the line of credit to be issued for acquisition purposes and for construction purposes
- Nature of payment of funds — a trust or in a bank
- Assignment and transfer of funds to others in the name of borrowers
- Miscellaneous assignments and successors
- Rights and liabilities of the lender
- Rights and responsibilities of the borrower
- Cost of taking the loan and its payment
- Repayment cycle and EMIs that need to be paid for the repayment
- Representations and Warranties of the loan
- Access to other utilities that form part of the loan
- Positive and negative covenants
- Compliance with various laws
- Acknowledgement that the taxes and other costs shall be paid by the borrower only
- Inspection rights and cooperation along with payment to the coordinator
- Insurance
- Reserves for statutory compliance
- Termination and Events of default
- Relevant disclosures
- Mechanic’s lien and first charge on the assets to the lender
- Remedies for default
- Miscellaneous provisions like warranties of the lender, conditions in the contract, etc.
How to Draft the Acquisition and Construction Loan Agreement?
When drafting an acquisition and construction loan, some points that need to be kept in mind are
- What part of the loan is allotted acquisition and construction
- How is the loan amount decided for each activity between acquisition and construction
- How model units would be treated
- Whether the loan issued can be transferred for the benefit of the third party
- The process of making application to the lender
- How the limitations on funding would be calculated and assigned to each part of the funding process
- What conditions must be satisfied before the loan can be foreclosed or repaid more than agreed
- What reports should the lender receive before allowing the disbursement of funds
- How the lender would appraise and approve the property
- Conditions before funds can be withdrawn from the pool reserved for the A&D
- What plans and specifications has the borrower provided the lender
- Conditions before payment of final advances to the borrower
- In what form would the lender disburse the funds to the borrower
- Responsibility of loan fees
- Acknowledgement of responsibility of statutory costs and compliance reserves
- What are the representations and warranties by the borrower and the lender
- What are the positive and negative covenants in the contract
- What are the events that constitute default
- What are the remedies available in case of a default
Benefits & Drawbacks of Acquisition and Construction Loan Agreement
Benefits
- Because the borrower doesn’t have to take two loans, the costs that he has to pay for the loan will decrease
- Because there is only one loan, if his credit score is good, he can secure the loan at a low rate of interest
- It also hedges against future increase in the rates of interest if the borrower took two loans
- Payment tracking would be made easy because of the single loan
- The borrower has the power to allocate funds to acquisition and construction as may seem fit without compromising on the financial aspects of the decision
- The lender gains more revenue because of the large amount borrowed and the standard rate of interest
- Since there is a lien on assets, the lender can be assured that he’ll get back his loan
Drawbacks
The only drawback of the agreements is that they are complex and are not easy to complete. This agreement is flexible, but because of that, there is a high qualifying standard which makes it difficult to follow and complete the agreement.
What Happens in Case of Violation?
The contract usually sets what the events for default are, and the remedies for such default. It would also include the duration for curing the default. However, if the violation still persists, the borrower forfeits his collateral. In addition to that, since the lender has a mechanic’s lien, he can claim part of the asset for clearing his dues from the borrower. There is always the option of filing a suit against him for restitution and payment of compensatory damages.
To conclude, the Acquisition and Construction Loan Agreement is costly and complex, but it’s important to make use of this agreement in case of renovation, expansion, or buying a new property. It reduces the total cost of the loan and makes the houses cheaper for the buyers, and easier to repay for the borrower
Sample for Acquisition and Construction Loan Agreements
A sample of the agreement can be downloaded from below.
