The protections that New York affords a construction lender who properly documents and files a building loan contract and its accompanying Section 22 Affidavit, each of which is discussed in earlier installments of this series, isn’t unlimited. Those protections don’t extend to all construction costs which the lender might otherwise agree to finance. Instead, as noted in other installments of this series, New York protects building loan advances only to the extent that those advances are intended for construction costs deemed to be either a “cost of improvement” or the cost of an “improvement” as defined in the Lien Law.
What Constitute an “Improvement”?
An “improvement” under New York law includes not just the physical structure you typically think of as an improvement or the materials that make up that physical structure, but also certain imrpovement-related activities like “demolition, erection, alteration or repair of any [such] structure”. Drawings of the structure by architects or engineers, as well as plans or specifications and surveys “prepared for or used in connection with such improvement” are also considered parts of the improvement under the Lien Law. From there, the statute drifts into the curiously hyper-specific, and includes categories such as: (i) the reasonable rental value of machinery, tools and equipment for the period of actual use, (ii) the value of fuel consumed by motor vehicles owned or operated by a contractor while engaged exclusively in transporting materials to or from the project and, my personal favorite, (iii) real estate brokerage services in obtaining a tenant for a term of more than three years for other than residential purposes pursuant to a written brokerage contract.
What Constitutes a “Cost of Improvement”?
A “cost of improvement” expediture under New York law includes, among other things, “expenditures incurred by the owner in paying the claims of a contractor, an architect, engineer or surveyor, a subcontractor, laborer and materialman, arising out of the improvement.”
Less obviously, it also includes costs such as: (i) interest on the building loan itself, (ii) taxes on the purchase price or value of materials or equipment and (iii) insurance premiums that accrue during construction.
What Does Not Constitute an “Improvement” or a “Cost of Improvement”?
Basically what can only be described as “everything else.” This too isn’t obvious, and traps for the unwary lie all around in that everything else.
For example, interest on a building loan is considered a cost of improvement, but interest on a project loan isn’t considered a cost of improvement even if all interest due on the construction loan is a legitimate cost of construction (this series will discuss project loans and their relation to building loans in upcoming installments). Similarly, if less obviously, a lender’s counsel fees are considered a cost of improvement, but a borrower’s counsel fees are not.
Summary and Upcoming Installments
The upshot of these complexities is that only a cost of improvement can be properly itemized in a Section 22 Affidavit, and only loan proceeds that pay for either a “cost of improvement” and an “improvement” have the protections afforded a building loan under the Lien Law. And that in turn raises the somewhat thorny question of what happens when a mistake is made in a Section 22 Affidavit.
We turn to that question in the next installment of this series.
