Are financial institutions required to make inspections before funding progress advances on construction loans?

At this time, there are no state or federal legal requirements that inspections be made. However, as a sound loan administration practice, most financial institutions undertake such inspections on both residential and commercial construction loans.

Is the lender responsible to the borrower if the lender doesn’t inspect or inspects negligently?

Typically, the loan agreement requires that the borrower allow the lender to inspect at all reasonable times, that the inspections are only for the benefit of lender and cannot be relied upon by the borrower, and that the borrower must pay for the inspections. So typically, the lender has no contractual liability relating to the inspections. Many borrowers have the mistaken impression that, since the borrower is paying for the inspections, the borrower can rely on the inspection. The loan officer should make clear prior to closing that the borrower-paid inspections are for the benefit of the lender only.

What about tort liability?

Possibly, although unlikely. If the loan officer held out to the borrower that the inspections were for the benefit of the borrower, a "course of dealing" might alter the written contract provisions. Also, if the inspector negligently caused injury to persons or property, the lender may have liability to the borrower/owner.

Must inspections be done at every draw?

The primary purpose of a progress inspection is to make an independent determination that the work the contractor indicates has been completed on the draw request, has actually been completed. Most lenders require progress inspections as a condition to funding each draw request. However, some lenders may elect to conduct inspections at certain intervals (such as once per month) rather than for each draw request.

Can the lender hire the borrower’s architect to do the inspections?

Some lenders will allow this on small commercial projects with the assumption that the architect is reliable and acting in this dual capacity will save the customer money. The lender, however, should keep in mind that the architect who undertakes this additional responsibility has an inherent conflict of interest.

When is it important to use engineers or architects for inspections?

Typically, only on large commercial projects where special expertise is required. This would include construction loans on office buildings, special use buildings and land development. The lender should check the engineer’s or architect’s experience in inspecting prior to engaging the professional.

Should the borrower be given a copy of the inspection report?

No, unless the inspection report is unsatisfactory and the draw request is denied. The customer and the contractor have the right to know why the draw request was denied.