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Paul Zimmerman

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Subordination Agreement Risks: Although a Standard Document, Due Diligence is Required

You have finally found buyers for that vacant lot. Given market conditions and the lending climate, you are asked to “carry back” (e.g., seller finance) a significant portion of the purchase price. Due to the buyers’ need for a construction loan, you are asked to sign a subordination agreement, automatically putting your loan in second-lien position. If you refuse to sign the paperwork, the buyers will back out because they need the construction loan for development; the construction loan will be first-lien. After careful consideration, you acknowledge that these agreements are commonplace and that this is the best alternative if you want to complete the transaction. However, many months later you find out that the Bank prepared a side letter of understanding (LOU) with the buyers that advanced funds and adjusted certain loan terms. You were never notified and, had you been aware, certainly would not have agreed to “carry back” financing, becoming a junior lien holder. The terms and disbursement provisions of the construction loan agreement have been contradicted by this LOU.This puts the security for your loan at risk and you stand to lose your entire security interest in the deal.

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This article is not offered as, and should not be relied on as, legal advice. You should consult an attorney for advice in specific situations.