Construction Defect – Insurance Exclusions For Lenders

I’ve been talking about the issue of construction defect for a few years now.

Here is the scenario. Your bank loans money to a developer for an apartment complex. Prior to completing the project, the developer goes under. You foreclose and sell the project to developer number two, who finishes the buildings and sells them. Two years later it’s found that the windows are improperly installed and that there is $1,000,000 of mold damage that needs to be repaired. As the bank was, during the REO stage, an owner of the property, you get sucked into the suit.

Your general liability policy has no coverage for construction defects.  Neither does your lender liability or executive liability.

Some attorneys are starting to recommend that banks put REO property into separate entities (usually LLCs) to protect the bank’s assets. Such does not solve the insurance problem, but could segregate bank assets to limit what a claimant can get access to.

Construction defect is an issue that had been debated in the insurance world for a few years.  Contractors struggle to have insurance to cover the issue – most do not.