Most construction lenders understand the importance of clear lot inspections in construction lending. Different lenders have different procedures on how and when the inspections are conducted. Under Texas law, early start of construction can be very problematic for lenders. In a homestead situation, if construction commences before the lender's lien is executed, the lien is invalid. This is true whether the homestead is a business or residential homestead. Section 53.059 of the Texas Property Code requires the written contract creating the lien (the mechanic's lien contract) be executed before material is furnished or labor is performed. Texas case law is very liberal as to what constitutes commencement of construction. Cases include clearing the land, setting the batter boards, and dropping lumber on the property.

In nonhomestead situations and homestead situations where the work is commenced after execution of the loan documents but before recording, Texas case law provides that the liens of all subs and suppliers providing labor and/or materials under a general contract "relate back" in time to the first work undertaken under the general contract. If, for example, a concrete forming sub began work prior to recording of the deed of trust, the liens of all subs and suppliers under the general contract would be superior to the lender's liens.

Clear lot inspections are done to detect an early construction start. They are typically undertaken the day that the closing is to occur. They typically are done by an agent or employee of the lender, but sometimes are done by the title company. Many lenders have a written form to evidence completion of the inspection; some even require photos and an affidavit of the person completing the inspection.

Although greatly minimizing the lender's risk, same day inspections may not eliminate the possibility of an early start. The pertinent event is the recording of the lender's lien. On several occasions, our firm has been involved in situations where a clear lot inspection was done on a Friday, the loan documents were signed on a Friday, but the title company did not get the lien documents recorded on Friday. Work commenced over the weekend, and the title company would not record the documents or issue a binder or policy because of the early start. This situation is rare, but does occur.

Thus the most conservative policy would be to require construction not to begin until after the deed of trust is recorded followed by a clear lot inspection being done. Obviously, if the lender is advancing funds at closing towards the cost of the land, though, the lender has to fund monies which will be "at risk" until the lot inspection results are obtained. Thereafter the lender can also obtain and record a separate Affidavit of Commencement to provide evidence of construction timing. If the lender is only advancing construction funds, then this procedure is clearly the most conservative approach.

This practice of some lenders to close the loan, fund the initial lot draw, record the lien documents, and then do the clear lot inspection, is an excellent way to detect early construction starts; the construction loan agreement would provide that the lender has no obligation to fund any portion of the construction allocation if an early start had occurred. On the other hand, because of the initial lot funding, the lender is already in the loan. Once funding has occurred, the lender is no longer in a position to walk away from the deal and must work with the builder to overcome the lien priority problems caused by the early start. On a homestead deal, this means termination of the existing general contract, verifying payment out of funds of borrower other than the loan, and some delay before redocumenting the new general contract. In a builder-direct loan, usually, each "sub" and supplier is an original contractor, and thus, is not entitled to the "relation back" lien priority of the other original contractors who started working prior to recording of the lender's lien.

As you can see from the above discussion, an early start on a builder direct loan (where vendors would be considered original contractors rather than subcontractors) does not create the severity of problems as in a situation where all or most of the work is done under one general contract. On a builder-direct loan, for example, if the slab gets poured before the lender's lien is recorded, the liens of the forms contractor, concrete contractor, plumber and concrete supplier would be considered superior to the lender's lien. Loan proceeds could be used to pay these contractors and once paid, the lien priority problem would be solved. But on a three party loan involving a sole general contractor, if work is started early, all of the general contractor's subs' and suppliers' liens will be considered prior to the lender's lien. Additionally, on loans on homestead, loan proceeds cannot be used to pay for the early work.

Thus, if the lender is expected to fund any monies at the closing, the policy should provide for both education of the borrower and contractor and a calculated decision on the likelihood of becoming involved in the serious difficulties attendant to an early start. We recommend the following steps:

1. The standard policy in all cases should be to advise the borrower, and if known, the Contractor, in writing that no work can commence until after the deed of trust is recorded.
   
   
2. The lender should determine that the lien has been filed for record and advise the borrower that work can begin. This means the lender has to follow-up with the title company to find out when the documents are tendered to the county clerk. In extreme cases, the title company runner can call the title company or the lender and advise them filing has occurred.
   
   
3. If possible, the transaction should be structured so that all the borrower's equity is put in before the lender advances fund so that no land purchase or land equity take-out advances have to occur at closing.
   
   
4. In cases where there is a single general contractor or a homestead (i.e. only one "original contractor"), step 2 becomes very important.
   
   
5. In cases where there are multiple original contractors, the exposure should be quantified by the lender and step 2 should be considered.
   
   
6. Clear lot inspections should be done as close to the filing of the lien as is possible.
   
   
7. In extreme cases, where step 2 is involved, the inspector should be lined up in advance to inspect after being advised by the lender that the lien has been filed.
   
   
8. Affidavits of No Prior Activity should be obtained prior to funding.
   
   
9. Affidavits of Commencement should be obtained (and may be recorded within the first 30 days) prior to a construction draw.