Completion Guaranties Revisited

Brian D. Hulse & Kevin Badgley
Brian D. Hulse & Kevin Badgley

Brian D. Hulse & Kevin Badgley

Brian D. Hulse is a partner with the Seattle office of Davis Wright Tremaine LLP and Kevin D. Badgley is an associate with the Seattle office of Davis Wright Tremaine LLP

Authors’ Synopsis: Construction loans commonly include a guaranty that the guarantor will cause the completion of the contemplated improvements on time, without liens, and in accordance with the plans approved by the lender. However, very little reported caselaw deals with completion guaranties and none of it is recent. This Article explores typical provisions of completion guaranties and the relevant caselaw. It then provides some suggestions for drafting such guaranties, including an appendix with sample provisions.

I. Introduction

The completion guaranty is a familiar feature of modern construction loans. Lenders typically require at least a completion guaranty where they do not have satisfactory full repayment guaranties of the entire loan amount. Often, principals or sponsors of borrowers are not willing to provide full repayment guaranties, but are willing to take on more limited guaranty liability including guaranteeing timely completion of the project and payment of project costs.

The obligations under a completion guaranty are sometimes hard to distinguish from, and overlap with, those under a related type of guaranty known as a “carry guaranty.” As used in this Article:

Completion guaranty means a guaranty the main thrust of which is to guarantee (i) completion of the contemplated construction project in conformity with approved plans and specifications and in compliance with applicable laws and permits, (ii) by a required deadline, and (iii) without liens;1 and

Carry guaranty means a guaranty of a variety of costs relating to the financed property (other than design and construction costs) over a period of time specified in the guaranty, including such “carry costs” as property taxes, insurance premiums, maintenance and management costs, utility charges, ground rent (if applicable), interest, etc.2

Such simple descriptions mask the complexity of these guaranties and the widely varying terms they include in practice. Completion and carry guaranties overlap in concept in that a completion guaranty’s guarantee of timely completion of the project includes an obligation to pay damages for delay if the project is not completed on time.3 Those delay damages include the same kinds of items listed above as typically covered by a carry guaranty. This Article’s discussion of completion guaranties will include carry costs to the extent they are included in damages to the lender from delay in the completion of the project beyond the deadline in the loan documents. Carry guaranties are often entered into to protect against risks other than those arising strictly from delay in completion of the project, for example delays in lease-up of the project unrelated to delayed completion of the improvements, inability to lease the project at the anticipated rents, etc.4 These kinds of carry guaranties often run until the project is stabilized (i.e., meets a specified debt service coverage level or some other financial milestone).5

This Article will begin by exploring the risks encountered by construction lenders and the strategies they use to address those risks. It will then review typical provisions of a completion guaranty as observed in current market practice followed by an examination of the relevant case law. Finally, it will explore some possibilities for improving the drafting of completion guaranties.

II. Goals and Strategies of the Parties

The financing of a construction project is a risky endeavor. There is the ever-present risk of the borrower’s overall creditworthiness. In addition, there is substantial risk that the project will not produce the expected financial returns due to the myriad possibilities of cost overruns, disputes with contractors or material suppliers, construction delays, defective work, difficulties in leasing up the completed project at the anticipated rents, etc. Lenders, borrowers, and guarantors are acutely aware of these risks and use a variety of strategies to minimize them or to impose them on other parties.

Lenders’ strategies to minimize the risk of construction loans include the following:

  • An analysis by the lender of the financial viability of the project and of the track record of the borrower, its principals, and the architects, engineers, and contractors the borrower intends to use;
  • In some cases, a pre-leasing (for rental projects) or pre-sale (for condominium projects) requirement that the borrower must meet for the lender to begin or continue advancing loan proceeds;
  • A feasibility review by the lender and its construction consultant of the principal construction documentation, including the construction contract (which must be a fixed price or guaranteed maximum price contract), plans and specifications for the project, a detailed project budget (with contingency line items as cushions against cost overruns), and project schedule;
  • Restrictions on the borrower’s right to materially modify the approved plans, construction contract, other project contracts, budget, or schedule without the approval of the lender;
  • A requirement that the borrower pay the initial portion of the costs of the project (usually at least 35%) with equity capital6 before the lender begins to advance the loan proceeds;7
  • Monthly advances of loan proceeds on a percentage of completion basis, as reviewed by the project architect and the lender’s consultant (less an agreed retainage held back to be disbursed at completion of the project or in increments as specified portions of the work are completed);
  • Monthly or more frequent inspections of the project by the lender and its consultant;
  • A requirement for lien waivers from the contractor, sub-contractors, and material suppliers and for title insurance endorsements insuring the absence of intervening liens or other encumbrances, as conditions to each advance;
  • A requirement that the borrower keep the loan and budget “in balance” (in other words, to deposit cost overrun amounts not anticipated in the budget with the lender, which the lender will disburse like loan proceeds before further advances on the loan are made);
  • In some cases, a requirement that the contractor provide payment and performance bonds (although these are expensive and often not required by lenders); and
  • Most relevant to this Article, a requirement of guaranties in favor of the lender, which may include one or more full or partial payment guaranties, completion guaranties, carry guaranties, or nonrecourse carveout (“bad act”) guaranties.8

In a completion guaranty, the lender wants to have sufficiently effective remedies against the guarantor so that it never needs to call the guaranty because the guarantor will have an incentive to ensure that the borrower completes the project, even if the guarantor has to fund additional equity infusions. To that end, the lender will seek remedies provisions in the completion guaranty that are discussed later in this Article.

The completion guarantor has its own concerns. It wants the following:

  • The scope of the guaranteed obligations to be as narrow as possible;
  • The scope of the required improvements not to be expanded beyond the improvements the lender agreed to finance (for example, by changes to the plans and specifications, or by requiring the guarantor to guarantee completion of tenant improvements or other work that is not included in the improvements the lender agreed to finance);
  • To have the ability to draw the undisbursed loan proceeds allocated to constructing improvements to pay completion costs if the guarantor completes construction;
  • To have any loan proceeds that are ultimately not disbursed by the lender deducted in calculating the damages payable under the guaranty (on the theory that the lender’s original bargain was to fully disburse the loan in return for having the completed project as its collateral);
  • To make clear that its carry obligations for delayed completion end at an appropriate, well-defined time; and
  • To make clear that the guarantor’s obligations are satisfied when the loan has been repaid in full and the lender has no further obligation to make advances (even if construction has not been completed and carry costs have not been paid).9

These competing concerns will be explored in greater detail in the rest of this Article in the context of typical provisions of completion guaranties and the relevant case law.

III. Typical Provisions of Completion Guaranties

Completion guaranties are usually very similar to garden variety repayment guaranties in most of their provisions. They contain all the usual consents by the guarantor to various actions the lender can take without releasing the guaranty, waivers of suretyship defenses, and other provisions found in the lender’s standard repayment guaranty. Where they differ from ordinary repayment guaranties is in their descriptions of the obligations guaranteed, the remedies for breach of those obligations, and the termination of the guaranty.

In the provisions unique to completion guaranties, such guaranties vary widely in their terms and language, although there are common themes and provisions. The authors reviewed dozens of samples of completion guaranties used in actual current construction-lending practice. The samples were from large and small lenders and were used in connection with loans that ranged in size from a few million dollars to more than a billion dollars. They were often characterized by unclear and complicated drafting, long run-on sentences, lack of precisely defined terms, and other awkward drafting making them difficult to read and interpret.

This part will review common provisions of completion guaranties used in current practice. Attached to this Article is a sample of the key sections of a completion guaranty. It contains typical provisions, but seeks to address the common drafting issues referred to above.

A. Obligations Guaranteed

The completion guarantor typically guarantees the following: (1) the lien-free completion of designated improvements by the contractual deadline and in accordance with the plans and specifications, applicable law, the loan documents, and other relevant contracts; (2) payment of all costs of design and construction of the improvements (including cost overruns); (3) payment of all required post-loan closing deposits of equity with the lender to cover cost overruns and keep the loan “in-balance”; and (4) payment of all damages to the lender for delay resulting from failure to properly complete the improvements by the deadline. These obligations are usually described in some detail.

B. Lender’s Remedies

If there is a default in the guaranteed obligations in that neither the borrower nor the guarantor completes the improvements by the specified deadline, the lender has various alternative remedies, typically including the right to (1) demand that the guarantor complete construction of the improvements (sometimes expressly stating that the lender has a right to specific performance of completion by the guarantor) and to recover damages for the guarantor’s failure to perform; (2) complete the improvements itself through agents, contractors, or a receiver, and to recover the cost of completion and certain related amounts from the guarantor; and (3) recover damages for non-completion from the guarantor without completing the improvements.

Completion guaranties generally give the lender unfettered discretion to select among these remedies after default by the borrower with no obligation for the lender to complete the improvements or to require or allow the guarantor to do so.

C. Lender’s Right to Complete

The lender wants to have the ability to complete the improvements itself and to make appropriate changes in the plans and specifications, scope of the project, identity of contractors, material suppliers and design professionals, and other aspects of the project without releasing the guaranty or creating liability on the part of the lender. If the lender elects to complete, it would usually do so by having a receiver appointed and funding the work done by the receiver, or it would wait until it takes title to the property after a foreclosure. In either case, of course, the actual work would be done by a general contractor hired by the receiver or the lender.

The lender will usually provide in the guaranty that it has no liability for any errors or omissions it or its agents or contractors may make in completing the project, except for those attributable to its own gross negligence or intentional misconduct. It also wants to make sure that, to the extent it revises the plans, the construction contract or other aspects of the project within reason, those actions will not release the guarantor from liability on the guaranty.

D. Calculation of Damages

Completion guaranties frequently specify how damages for breach of the completion obligation will be calculated if the lender does not elect to complete construction itself. Frequently, completion guaranties go to some length to state that the lender is entitled to recover damages in the amount of the cost of completing the improvements, as estimated by the lender’s consultant or otherwise, and that the lender is not limited to recovery of the difference between the as-is value of the property and the value the property would have if the improvements were properly completed. Some-times completion guaranties provide that all or part of the undisbursed proceeds of the loan will be deducted from gross cost amount, but sometimes they do not. The guaranty may simply say that the damages will include damages resulting from delay in completion or it may go into considerably more detail about how that element of damages is to be calculated.

As discussed in detail in Part IV below, there is a long history of case law addressing the issue of whether the measure of damages for breach of an obligation to a mortgage lender to complete construction of improvements on the collateral property should be based on the cost to complete the improvements or, alternatively, on the value the improve-ments would add to the property if completed. As will be seen, not all of the discussion in these cases is enlightening, and none of them address the question of whether a liquidated damages clause specifying that the lender’s damages will be deemed equal to the cost to complete is enforceable.

E. Right to Draw Loan Proceeds if Guarantor Completes

The guarantor often wants the right to draw the remaining loan proceeds to fund its completion of the project if the lender requires the guarantor to complete. Lenders are usually willing to agree to that so long as they have no obligation to allow the guarantor to complete, and so long as various other conditions to such draws are satisfied, typically including such things as the following: (1) the guarantor has not defaulted; (2) the guarantor has the right to possession and control of the project; (3) the guarantor cures all defaults of the borrower that are curable by the guarantor; (4) the guarantor agrees to abide by the terms of the loan documents in completing; (5) all conditions of the loan documents to the disbursement of loan proceeds are satisfied, including making deposits of loan balancing payments to keep the budget “in balance” if there are cost overruns; and (6) there is assurance that the loan proceeds advanced to the guarantor will be an obligation of the borrower as well as the guarantor and, especially importantly, will be secured by the mortgage.10 The latter item may require a post-default, written consent by the borrower. Further, there is often a requirement that the borrower not be the debtor in a bankruptcy or other insolvency case or that, if the borrower is in bankruptcy, that the bankruptcy court enter an order allowing the guarantor to complete the project and providing that the additional advances will be obligations of the borrower and will be secured by the mortgage.

One wonders whether a lender would ever want to demand that a guarantor complete property improvements after a borrower’s default given that the guarantor will virtually always be a party with a close connection to, and probably control over, the borrower.11 The lender is likely to expect that, if the guarantor has the ability and willingness to complete the project, it will do so by acting through the borrower and providing funds to the borrower to achieve completion without the borrower ever going into default. If the guarantor has not, or will not, do so, it seems unlikely that the lender will want to demand that the guarantor take over the project, especially if the lender is obligated to continue advancing loan funds.

F. Termination of Guaranty

The lender wants to have a clear standard for when the required stage of completion has been reached and may specify that it has to be final completion rather than substantial completion, that all lien periods must have expired with no remaining filed liens, that any necessary certificates of occupancy must have been issued, etc.12

The guarantor would prefer that the guaranty be released upon substantial completion of construction.13 It will argue that substantial completion is the point at which the property can be used for its intended purpose, even if punchlist items necessary to achieve final completion are still in process.14 It also wants to make sure that, if the loan is repaid in full (whether through repayment of the loan or by the amount bid at foreclosure) and the lender has no obligation to advance any further funds, the guaranty obligation will be satisfied.15 That is not objectionable to the lender as the lender’s only real interest in completion of the improvements is as a means to ensure that its loan is repaid.16

IV. Case Law on Remedies

As noted above, there is relatively little reported case law addressing the issues that arise with completion guaranties.17 To the extent there are any useful “modern” appellate cases dealing with the subject, they were all decided between the mid-1970s and the mid-1990s. There is also a significant body of older (mainly prior to 1940) case law dealing with the analogous subject of performance bonds issued by surety bonding companies to guarantee completion of construction projects and various other types of contractual assurances that a construction project will be completed. The older cases illuminate how courts have viewed construction completion obligations in favor of lenders, especially with regard to the measure of damages for breach of the obligation.

This part will deal briefly with specific performance as a remedy for breach of a completion guaranty and will conclude that specific performance is unlikely to be requested by a lender and less likely to be granted by a court. It will then discuss the law on damages for breach of such a guaranty in much greater detail.

The fundamental principle in the damages cases is that the lender should have compensation such that it is made whole and left as well off as if the guarantor’s contract had been fully performed.18 This part will explore how courts have put that principle into practice. However, none of the cases, whether modern or early, thoroughly analyze a completion guaranty with the terms typical in current usage. Further, none have addressed the use of liquidated damages provisions in completion guaranties.

A. Specific Performance

It is common for completion guaranties to provide that the lender can demand that the guarantor actually complete construction. Many go on to state that the lender can obtain a court-ordered decree of specific performance to enforce that obligation. It is highly unlikely that a court would grant a decree of specific performance, and such a provision is not included in the sample provisions attached to this Article. Specific performance is generally available only where the legal remedy of damages is inadequate, even if the parties have stipulated in the contract to the availability of specific performance as a remedy.19 Of course, a lender’s interest can always be satisfied by the payment of money damages because its primary interest is to have its loan repaid.

Western Construction Co. v. Austin20 involved a guaranty that “all bills for labor and materials will be paid under the terms of the contract.”21 The trial court’s ruling was in the nature of a decree of specific performance in that it awarded judgment solely on the basis of the amount of the obligations the guarantor had guaranteed, but failed to pay.22 The Washington Supreme Court reversed on the ground that the nature of an action on a guaranty “is essentially one for damages for breach of contract” and “the measure of damages is the loss sustained by the guarantee by reason of the guarantor’s breach.”23

Further, specific performance is not available where performance is beyond the defendant’s power.24 That could be the case where, for example, the guarantor has no power to obtain possession of the property from the borrower to complete construction.25

B. “Modern” Cases on Damages

1. Glendale Federal v. Marina View Heights

The leading relatively modern case addressing completion guaranties is the 1977 decision of the California Court of Appeal in Glendale Federal Savings & Loan Ass’n v. Marina View Heights Development Co., Inc.26 Glendale Federal is a lengthy opinion involving complex facts and many issues unrelated to the subject of this Article. However, more than forty years after it was decided, its analysis of completion guaranties remains the most detailed of any modern reported case. Because of its continuing influence, the Glendale Federal case is discussed in some detail in this Article.

In the late 1960s, Glendale Federal made loans totaling more than $12,000,000 to the borrower to acquire and improve certain properties, and it received completion guaranties from two individuals.27 The court provided only very limited descriptions of the terms of the guaranties, stating that the guarantors “individually guaranteed that Marina View would furnish all labor and materials ‘necessary for the construction of said building or buildings, and will fully complete the construction of same promptly and in accordance with . . . the terms and conditions’ of the ‘Building Loan Agreement.’”28 The court further stated that the guaranties provided that “in the event Marina View fails to complete the improvements, ‘guarantors would upon written demand’ either deposit sufficient money to cure the default or cause the work to be completed.”29

The borrower defaulted prior to completion of the improvements.30 In 1971 Glendale Federal completed foreclosure proceedings and was the purchaser at a nonjudicial sale for a credit bid of $6.65 million against a secured indebtedness of almost $11 million, leaving a deficiency in excess of $4.3 million.31 Glendale Federal sought damages for breach of the guaranties in an amount at least equal to the cost to complete the required improvements.32 The issue for appeal was the proper measure of damages for breach of the obligation to complete. The court of appeal described the trial court rulings as follows:

The trial court determined that if Glendale was fully secured on the date of the foreclosure sale it would have suffered no damage either as a result of the diversion of loan funds earmarked for [the relevant improvements] or by reason of the failure to complete the improvements. However, having found that Glendale was not then fully secured, the court determined that Glendale was entitled to recover as damages the ‘loss of security’ caused by the diversion of funds and the breach of the guarantee agreement. The ‘loss of security’ was found to be $700,000.

Glendale contends that the proper measure of damages for the breach of a construction contract is the amount required to bring the property into the condition it would have been had the contract been fully performed and not the loss of enhancement in value resulting from the failure to perform. The court having found that it would cost $900,000 to complete the [relevant improvements], Glendale urges that it should have been awarded at least that amount.33

Apparently, Glendale Federal did not complete the improvements after taking title to the properties, and the court of appeal stated that, while “the cost of completion was a relevant consideration,” the trial court impliedly found that “completion of the [improvements] would not have enhanced the value of the property to the extent of the actual cost of completing them . . . .”34

The court of appeal went on to describe its interpretation of the law on the measure of damages for breach of a contract to construct improvements on real property, drawing a distinction between a situation where the plaintiff seeking damages is the owner of the property and one where the plaintiff is a lender:

The proper measure of damages for breach of a contract to construct improvements on real property where the work is to be done on plaintiff’s property is ordinarily the reasonable cost to the plaintiff of completing the work and not the difference between the value of the property and its value had the improvements been constructed. A different rule applies, however, where improvements are to be made on property not owned by the injured party. In that event the injured party is unable to complete the work himself and . . . the proper measure of damages is the difference in value of the property with and without the promised performance, since that is the contractual benefit of which the injured party is deprived.35

Consistent with this reasoning, the court ultimately found that in an action for breach of a guaranty of the completion of real property improvements in favor of a lender, the lender’s recovery “is limited to the injury to the mortgagee’s security interest which is measured by the difference between the value of the property with and without the completed improvements.”36 This conclusion that the measure of damages for breach of a completion guaranty is the difference in value and not the cost to complete the improvements will be explored in greater detail later in this Article.37 It is worth emphasizing that, as discussed above, the lender in Glendale Federal never completed the improvements and there was an implied finding that completing them would not have been worth the cost.

The court went on, almost in passing, to make another important point—that the undisbursed portion of the lender’s loan needs to be considered in calculating damages.38 Although the court did not explain its reasoning on that point, it is obvious that the lender’s bargain in entering into a construction loan is that it will advance the proceeds of the loan, and when the loan has been fully advanced, it will have as its collateral the property with the completed improvements in place. If the unadvanced loan proceeds, or an appropriate portion of those proceeds allocable to construction and carry costs, are not deducted from the otherwise applicable damages calculation, the lender will have received more than it bargained for.

2. Black v. O’Haver

Later in the same year the California Court of Appeal decided Glendale Federal, the United States Tenth Circuit Court of Appeals decided another case dealing with a completion guaranty, Black v. O’Haver.39

The lender in Black made a construction loan for the construction of an apartment complex in Oklahoma.40 Several individuals executed a completion guaranty in favor of the lender.41 The borrower defaulted on the loan before the project was completed, and the lender foreclosed on the property, but the foreclosure sale produced insufficient proceeds to fully repay the loan.42 The lender did not seek a deficiency judgment against the borrower.43 It did, however, sue the guarantors on the completion guaranty, and the trial court granted it a judgment for, among other things, the costs and expenses of the receiver, of completing the project, and of paying amounts owing on judgments in favor of contractors and material suppliers.44 The lender had a receiver appointed, and, in contrast to the situation in Glendale Federal, the receiver completed construction of the project.45

On appeal, the guarantors argued that, under Oklahoma law, where a mortgagee does not successfully seek a deficiency judgment within ninety days after its foreclosure sale, the debt secured by the mortgage is deemed fully satisfied as to both the borrower and any guarantors.46 The court agreed with that proposition as to the borrower, but not as to the guarantors under the facts of the case and applicable Oklahoma law.47

Apparently, the guarantors did not challenge the trial court’s calculation of damages based on the cost to complete rather than on the difference between the value of the property with and without the improvements, and presumably the lender actually incurred the cost to complete by advancing that amount to its receiver.48 The Black court did not cite to the Glendale Federal case.

3. 1633 Associates v. Uris Buildings Corporation

In 1979, New York’s intermediate appellate court decided 1633 Associates v. Uris Buildings Corp.,49 which involved a $62 million loan made in 1969 to finance a 48-story office building in Manhattan.50 After the borrower defaulted prior to completion, the lender foreclosed its mortgage and, for unexplained reasons, bid an amount somewhat in excess of the secured debt at the foreclosure sale, leaving no deficiency.51

After taking title to the property, the lender completed the improvements at a cost of $1.2 million, paid off $800,000 of contractors’ liens on the property, and sued the completion guarantor to recover those amounts under its guaranty.52 The court denied any recovery, holding:

It should be noted that the principle of compensation is not that the plaintiff should be more well off than he would have been had the contract been fully performed, but that he simply should be made whole. This is the critical legal principle operative herein as set forth in the legal precedent. As [the lender] purchased the property at the foreclosure sale for some $2,066,000 more than the mortgage debt, and as the sum expended by it to complete the building and to pay off the liens is approximately $2 Million, which is less than that amount, it becomes clear that the plaintiff has already been made whole. Accordingly, to permit recovery under the guaranty of completion would enable the plaintiff to be more well off than if the contract had been performed, which is at variance with the legal precedent stated above.53

The 1633 Associates court recognized that, if foreclosure sale proceeds exceed the amount of the loan obligations, a completion guarantor’s liability is satisfied.54 It does not matter that, after becoming the successful bidder at the sale, the lender invests additional amounts in completing the improvements and clearing liens.55

The 1633 Associates opinion cited to neither Glendale Federal nor Black, but like Glendale Federal did cite to several early surety bond cases.56

4. Jetero Corp. v. BankAmerica

In Jetero Corp. v. BankAmerica Realty Investors,57 a case decided by the Tennessee Court of Appeals, the borrower of a condominium construction loan surrendered possession of the incomplete project to the lender with various defects in the work. The lender later sued the completion guarantor for “what [the lender] spent in order to repair the defective workmanship of Jetero and to complete the project so the units would be salable.”58 Some of the work done by the lender “may have been done outside of and beyond the original plans and specifications.”59 The trial court, on a basis that was not clear, did not award the lender any damages.60

The court of appeals reversed and remanded for further proceedings.61 It held that the lender was entitled to recover its costs and expenses in correcting certain defects and completing the project (apparently including additional costs and expenses resulting from the changes in the plans and specifications, as provided in the guaranty).62

The decision in Jetero was similar to Black in that the lender actually completed the improvements and was awarded damages based on the cost of doing so.63 However, the court did not cite to any of the above cases or to any of the older surety bond cases in support of its decision, nor did it engage in any discussion of the appropriate measure of damages for breach of a completion guaranty.64

5. Chase Manhattan v. American National Bank

Chase Manhattan Bank, N.A. v. American National Bank & Trust Co. of Chicago,65 a Second Circuit decision, dealt with a completion guaranty in connection with an acquisition and renovation loan for an office complex located in Illinois.66 The guaranty, which was governed by New York law,67 provided:

[bq]We agree that, for purposes of this Guaranty, [Chase’s] aforesaid Direct and Indirect Costs shall, at [Chase’s] sole option, be equal to either (i) the aggregate amount of such Direct and Indirect Costs actually incurred by [Chase] . . . or (ii) the amount of such Direct and Indirect Costs as estimated by the Construction Consultant at any time after maturity or such acceleration of the loan. . . . We agree that, for purposes of this Guaranty, your aforesaid Direct and Indirect Costs shall, at your sole option, be equal to either (i) the aggregate amount of such Direct and Indirect Costs actually incurred by you from time to time to and including the date on which the Improvements are completed, lien free, and the conditions of the final advance of loan proceeds . . . under the Building Loan Agreement have been satisfied in full or (ii) the amount of such Direct and Indirect Costs as estimated by the Construction Consultant at any time after maturity or such acceleration of the loan.68

The lender foreclosed on the property and demanded payment of approximately $4.5 million from the guarantors.69 The market for suburban office buildings in Illinois had collapsed between the time the loan was made and the time of the foreclosure.70 The amount demanded was based on the high end of the range of estimated costs to complete the improvements prepared by the lender’s construction consultant (the estimated costs varied depending on the number of tenants to occupy the project).71 The lender did not actually complete construction or make any improvements to the property before selling it.72

The court held that the wording of the guaranty required that the lender actually incur costs of completion in order to be entitled to recover under the guaranty, and it remanded the case to the trial court with instructions to enter judgment for the guarantors. In doing so, it stated:

Under the Guaranty, [the guarantors] agreed to reimburse Chase for any costs that Chase incurred or was required to incur in connection with the completion of any Improvements that were not finished by [the borrower]. Thus, if Chase expended funds to complete the Improvements, or if Chase was required or undertook to do so, [the guarantors] would be obligated to reimburse the amounts expended, or a good faith estimate of those amounts. But we think that nothing in the wording of the Guaranty requires [the guarantors] to pay the estimated cost of Improvements that were not made, were not required to be made, and never will be made.73

This case provides a lesson in careful drafting. The lender argued “that it suffered damages by reason of the ‘probable loss of value’ attributable to the property’s incomplete state, and that ‘the proper measure of [the lender’s] damages was the cost to complete the renovation not the value the renovations would have added to the Property.’”74 The court noted that the outcome might have been different if the guaranty had provided that the guarantors would pay damages for breach of the obligation to complete construction, but unfortunately for the lender it did not.75

C. Early Cases on Damages Under Analogous Contracts

Prior to the cases described above, there was a long history of appellate cases in which courts addressed contracts similar to completion guaranties. Some involved performance bonds issued by corporate sureties in the business of insuring the completion of construction projects.76 Others involved contracts, often referred to by the courts as “bonds,” under which a party not in the surety bond business provided a similar assurance of completion of a project.77

As noted above, Glendale Federal and 1633 Associates cite some of the early cases, but the other more modern cases do not. The early cases delve into the remedies available to the beneficiary of a completion bond or guaranty in greater depth than do the more modern cases. They address a number of relevant issues, including (a) whether the lender’s damages should be based on the cost to complete the improvements or on the difference between the value of the property with the incomplete improvements and the value it would have if complete, (b) the availability of damages for delay in completion, (c) the effect of foreclosure of the lender’s mortgage, (d) the effect of the lender completing construction, and (e) the effect of the lender not having fully advanced its loan.

It is important to keep in mind that the early cases do not involve the more detailed completion guaranties that are typical in current real estate finance practice. Where the terms of the contracts can be determined, they tend to be very short and only require completion of the specified improvements.78

1. Base Measure of DamagesDifference in Value or Cost to Complete?

a. Majority and Minority Views

Most of the early cases awarded the lender damages based on the difference in value between the value of the property with the incomplete improvements and the value of the property with the completed improvements as of the date of the breach of the obligation to complete, and not on what it would cost to complete the improvements.79 Where the breach consisted of defects in the construction, courts recognized that the difference in value should be calculated as of the date the lender had notice of the defects or could have had such notice by the exercise of reasonable diligence.80

A minority of cases held to the contrary that the lender is entitled to recover the cost to complete or correct construction.81

Many of the early cases do not clearly make a distinction between the appropriate measure of damages where the plaintiff is a lender rather than the owner of the property.

(1) Cases Taking the Minority View

The minority cases bear further scrutiny. The Pennsylvania Supreme Court in Purdy v. Massey82 held for the minority rule over a dissent arguing for the majority rule.83 The Tennessee Supreme Court in Crump & Trevezant, Inc. v. Continental Casualty Co. also held for the minority rule, but focused on a fact specific to the case that the lender intended to sell its loan to an insurance company, which would buy it only with the completed building.84 The case law taking the minority view largely arises from a rather confusing series of early cases from Pennsylvania of which Purdy is a leading example.

The courts in both Purdy and Crump rested their decisions in part on a supposed technical distinction between a contract of indemnity and a contract of guaranty.85 The Purdy court described the distinction as follows:

Is this bond one of guaranty or merely an indemnity against loss? ‘The distinction between the two agreements is simply that between an affirmative covenant for a specific thing, and one of indemnity against damage by reason of the nonperformance of the thing specified.’ Weightman v. Union Trust Co., 208 Pa. 449, 57 A. 879, 880. In answering this question, the language of the bond itself should first be considered. If it is plain and unambiguous that the covenant is to do a specific thing, as, for instance, the erection of a building (Equitable Trust Co. v. National Surety Co., 214 Pa. 159, 63 A. 699, 700, 6 Ann. Cas. 465; Trainor Co. v. Aetna Casualty & Surety Co. (D.C.) 49 F. [2d] 769), there can be no doubt that the bond is one of guaranty. The covenants in a bond ‘should be construed to mean what the parties intended, in so far as that intention can be ascertained by the words used.’ Equitable Trust Co. v. National Surety Co., supra. If, however, the language is not free from doubt, then the circumstances surrounding the making of the bond, and particularly the purpose for which it was given, should be taken into account. March v. Allabough, 103 Pa. 335; Ambridge Borough v. P. & B. St. Ry. Co., 234 Pa. 157, 82 A. 1105. In this case such considerations lead to but one conclusion-that this bond was an absolute undertaking to erect and complete the building.86

The trial court in Trainor Co. (discussed in detail later in this Article) summarily dismissed the distinction between contracts of indemnity and of guaranty, stating: “The plaintiff has made much of the distinction between these two classes of bonds, but, so far as I can see, there is no substantial difference in the measure of the damages.”87 However, the United States Supreme Court in that case viewed the distinction as one having more importance: “Plainly the obligation of the bond was one of guaranty and not indemnity, and could be fulfilled only by the erection of the buildings or payment of the penalty in case of default.”88 Both the majority in Purdy and the United States Supreme Court in Trainor Co. seemed to use a reference to the bond in question as a guaranty bond rather than an indemnity bond as a talisman for determining the proper measure of damages. The dissenting justice in Purdy considered the issue at greater length and in an analytical discussion determined that the distinction is irrelevant in a case where the beneficiary of the bond is a lender rather than an owner (and, in that case, a lender secured by a junior mortgage). The dissent’s position is worth quoting at length:

The majority opinion states: ‘The condition of the bond is performance of a specific thing, . . . and the only alternative for performance is the bond itself.’ This cannot be correct if it means that, in case the building is not completed, no matter to what extent, the surety will be liable for the penal sum of the bond; the penal sum merely limits the surety’s obligation, which is to reimburse the obligee for the actual damage which he has suffered or may suffer, Keck v. Bieber, 148 Pa. 645, 24 A. 170, 33 Am. St. Rep. 846; Montgomery County v. Ambler-Davis Co., 302 Pa. 333, 153 A. 621; or compensate him for actual loss. The opinion further states: ‘It is obvious . . . that the intent of all concerned was to give plaintiff in lieu of her first mortgage the enhanced value of the real estate by the addition of the building, or failing that, its equivalent in money.’ It may be, and no doubt was, the intention to enhance the value of the real estate by the addition of the building, but it does not follow that the value of the land plus the completed building would equal or surpass the indebtedness on the first and second mortgage and thus afford adequate security for the second mortgagee; nor does the completion bond undertake that it will be tantamount to ‘its equivalent in money.’ The only logical inference is that of an intention to strengthen her security by the addition of the building.

The value of mortgagee’s security is not to be arrived at, as appellee seems to think it was bound to be, by treating the property as in a completed state, and separating the various parts of the land, i.e. the lot and this building, placing a value on the latter. Nor was the agreement to construct the building additional security beyond insuring or guaranteeing payment of the full amount of the secured mortgage, if the cost of completion equaled that sum. Suppose the completion bond covered both contracts, what would be the rule as to damages when, as here, the property sold for less than the first mortgage? But, in any event, the first mortgage might require for its satisfaction the entire value of the property with the building in a completed state, and thus utterly destroy the property’s value as a security to the second mortgage. The bond, under such circumstances, would be for the protection of a nonexistent interest; and no injury could possibly be said to have resulted from the contractor’s default, so as to give rise to a claim for more than nominal damages.

The rule of cost of completion as a measure of damage is undoubtedly correct where the obligee of the bond is the owner and not the mortgagee. The owner is, of course, entitled absolutely to the premises in the state in which it has been agreed they should be placed, viz., a lot with a completed building. In this situation, there is considerable authority supporting the rule. Union Indemnity Co. v. Vetter (C. C. A.) 40 F.(2d) 606; Boise City v. National Surety Co., 30 Idaho, 455, 165 P. 1131; Haney v. Ferch, 150 Minn. 323, 185 N. W. 397; Elmohar Co. v. People’s Surety Co. of New York, 217 N. Y. 289, 111 N. E. 821; Watters v. London & Lancashire Ind. Co., 76 Pittsb. Leg. J. 605; Gleason v. Smith, 9 Cush. (Mass.) 484, 57 Am. Dec. 62.

In this case, however, the obligee of the surety’s undertaking is not the owner of property, but a mortgagee, and a different rule is and should be applied, as the mortgagee’s interest is different, and his loss occasioned by a failure to complete is likewise different. The owner is entitled to have his building as contracted for, but the mortgagee has no such contract as will entitle him to enforce such liability. The mortgagee has no interest in the property as such (it is only security for his debt); and the fact that a bond is given guaranteeing completion of a certain building upon it adds nothing to this status, nor does it alter or increase the holder’s rights under his mortgage with respect to that property, though it may add to his security. The mortgagee has an interest in the property only in so far as the property stands as security for his debt; beyond this, he has no further interest. All he is entitled to in any case is full and adequate security for the sum he has advanced, and it is difficult to see how he can become entitled to anything more than this by virtue of the surety’s undertaking as noted in the completion bond under consideration. The court below, having taken as the measure of damages the cost of completion, was, in my opinion, in error. It may often be that an incompleted structure will be of sufficient security value to protect the mortgagee, or that the land itself may be sufficient for this purpose. It seems plain that in such a case it could not be laid down as a rule that the mortgagee, who is adequately protected, would, by virtue of his bond, be entitled to collect what it would cost to construct the building in its entirety no matter to what extent it might be incompleted.

The contract in that case was held to be one of indemnity, but, as explained above, the rule for ascertainment of damages should be the same whether the contract is one of indemnity or guaranty.89

Ultimately, it seems that the technical distinction, to the extent it has any validity, should fall before the analysis of the Purdy dissent and cases such as Glendale Federal that take a more nuanced approach to the damages suffered by the lender and do not rely on such archaic labels.90

The Purdy majority stated, “Our recent case, Mechanics’ Trust Co. v. Fidelity & Casualty Co., 304 Pa. 526, 156 A. 146, 147, is directly in point.”91 However, it is interesting to note that the court in Mechanics’ Trust appeared to place some weight on the fact that the lender had actually completed construction at its own cost, explaining:

The measure of damages then, where the contract is breached, follows the general rule that the injured party should be placed in the same position as if there had been no breach. If there had been no breach, the houses would have been completed; accordingly, the measure of damages to plaintiff, since, to protect itself, it bought in the houses and completed them, is the cost of completion, providing that cost was reasonable.92

The improvements in Purdy were never built.93 The fact that the lender in Mechanics’ Trust actually completed construction is arguably a material distinction between the two cases and, where the lender takes that approach, it seems more just to treat the amount it reasonably spends to complete the project as an appropriate measure of that component of the lender’s damages rather than to look to appraisal evidence of the value differential. In such a case, unless it is clear that the lender acted unreasonably, the amount spent by the lender reflects its actual damages and is not subject to the vagaries of expert appraisal testimony.

(2) Trainor Co. v. Aetna Casualty & Surety Co.

Trainor Co. v. Aetna Casualty & Surety Co.94 merits discussion both because it was cited by Glendale Federal and because it was ultimately decided by the United States Supreme Court.

Trainor Co. was a Pennsylvania federal court case the trial court decided the year before the Pennsylvania Supreme Court’s decision in Purdy, and the Third Circuit Court of Appeals’ and the United States Supreme Court’s decisions followed shortly after the Purdy decision.

The case involved a loan to finance construction of fifty two houses, which was secured by what was in effect a third mortgage on the property.95 The borrower defaulted when twenty four of the houses had been completed and 28 were uncompleted.96 The trial court found that, on the deadline for completion under the loan documents, the value of the property with the uncompleted houses was slightly higher than the amount secured by the lender’s mortgage and prior liens, but under the terms of the mortgages, the lender was not able to foreclose at that time (presumably due to the terms of an agreement with the senior lienholder).97 Ultimately, the holder of the first priority mortgage foreclosed and wiped out the lender’s position.98 The trial court held that the appropriate measure of damages on the completion bond would be based on the difference between the value of the incomplete improvements on the date of breach and the value on that date had the improvements been completed; however, it awarded the lender only nominal damages because the incomplete project was worth enough to pay off the lender’s loan as of the date of the breach.99

On the first level of appeal, the Third Circuit affirmed the trial court’s decision, holding that it was not bound to follow the Purdy court’s approach.100 The court quoted the following statement of the trial court with approval:

The trial judge, after stating the law as to the rights of a landowner against a builder where the latter fails to complete, and calling to attention that the present case is not one of an owner but of a mortgagee, says: ‘A mortgagee of land upon which buildings are to be erected is, however, not in the same position as the owner. Except as it affects the security for his loan he has no genuine interest in the completion of the work. Obviously, the contention of the plaintiff in this case that the mortgagee like the owner is entitled to the difference in the value of the completed and the uncompleted job, regardless of the value of the land or the amount of the mortgage, is unsound. If that were so, the holder of a mortgage secured ten times over by the value of the land alone, and having no other interest, could recover from a surety large damages for the breach of a contract to build an expensive structure upon it. The fundamental principles and policy of the law above stated forbid such result.101

The Supreme Court reversed, following Purdy without holding that it was bound to do so, and stated:

It is very clear that the settled rule in Pennsylvania is to the contrary. In Purdy v. Massey, 306 Pa. 288, 159 A. 545, where prior cases are deviewed, the court held that where there is an absolute undertaking to erect and complete a building, the surety in case of default is bound to take the place of the principal and erect the building, and the cost of doing that which should have been done is the measure of damages for which the surety is liable, not exceeding the amount of the bond . . . . In the instant case, the bond guaranteed the completion of the building; if there had not been a breach of the obligation of the bond, the building would have been erected. Since this was not done, the plaintiff can only be put in as good position as if the contract had been carried out by giving her the cost of construction, not exceeding, of course, the amount of the bond.102

Oddly, after stating that the cost of completion is the basis of the measure of damages, the Supreme Court went on to refer to the difference in value as the proper basis.103 However, the court ultimately awarded the plaintiff lender damages equal to the amount the senior lienholder spent to complete the improvements before foreclosing.104

b. Reconciling the Majority and Minority Views

A review of the New York Court of Appeals’ 1881 decision in Kidd v. McCormick,105 which was cited by the Trainor Co. court, provides a route to reconciling the decisions holding that the measure of damages is the difference in value with those decisions holding the proper measure is the cost to complete. The court in Kidd stated:

I am aware that there has not been harmony in the expressions of learned judges, in passing upon the question of the measure of damages. I apprehend, however, that it has been principally in pointing out the kind of testimony by which the amount of damages was to be got at, rather than in the rule that was to govern. Stated in its broadest form, the plaintiff is to have that compensation, which will leave him as well off as he would have been had the contract been fully performed. With more particularity, he has a right to a house as good as that which the defendants agreed to furnish; and his damages is the difference between the value of the house furnished and the house as it ought to have been furnished. One kind of testimony by which that difference may be made known, is that of experts, saying what would have been the value of the one, and what is the value of the other. Another kind of testimony is that of experts, what it would cost to complete the unfinished house up to the mark of the contract. Another kind is, when the house has been in fact finished, up to that mark, what it did in fact cost to finish it. But these ways all lead to the same end; what is the difference in value between the unfinished house and a house had it been finished as agreed upon. And this is to be observed of the last-named kind of testimony; first, that the plaintiff is not under obligation to go on and finish the house; second, that he cannot always finish it, as he could not in the case in hand, at the day called for by the contract, when there will come into the damages the element spoken of by Marvin, J., in 33 N. Y. (supra) of loss from delays; and third, that the cost of actual building may have increased after the day of performance, and so be a detrimental gauge of damage for the defaulting contractor. Yet the referee received testimony in each of these ways, and therefrom reached a result, by the application to the facts thus before him of the rule we have above stated. We think that he made no error.106

On this analysis, the cost to complete may be evidence of a portion of the difference in value between the incomplete project, and the completed project as of the relevant date.107 Other components would include losses resulting from delay in the project (including carrying costs and increased costs of construction), price reductions demanded by buyers for the risk and inconvenience of completing construction, etc. Less than three years after the Trainor Co. decision, the United States Supreme Court followed this line of reasoning in its opinion in Prudence Co., Inc. v. Fidelity & Deposit Co. of Maryland.108 In that case, apparently decided under New York law, the Court discussed the various factors that would lead to a decrease in value following a failure to complete the improvements by the required deadline and again cited Kidd in describing the alternative methods a lender might use in proving the difference in value.109

The limits of evidence of the cost of completion as probative of the loss of value from the failure to complete was recognized in United Real-Estate Co. v. McDonald,110 where the court noted:

It is not a presumption, either prima facie or conclusive, that a building necessarily adds a definite amount to the value of property in a city. So much depends upon the purposes for which the property is to be purchased and the character of the buildings. A building which would be valuable in one locality would be a positive detriment in another locality; as, for instance, a dwelling house in an exclusively business district.111

One can easily imagine examples of situations where circumstances have changed so that, for one reason or another, it has become uneconomic to complete the project. For example, in Province Securities Corp. v. Maryland Casualty Co.,112 no tenants were available for the property after the lender completed the project. However, these kinds of facts would seem to go to the weight of the evidence, but not to be a reason to exclude cost to complete evidence in all cases.

c. Effect of Actual Completion by Lender

The courts seem much more likely to base a damages award on the cost to complete where the lender actually pays to complete the project. Where the lender puts its own money on the line and takes on the risk and inconvenience of having the work completed itself, this outcome seems appropriate unless the guarantor can demonstrate that the lender has acted unreasonably in doing so.

The court in Mechanics’ Trust took this approach and held that, where the lender actually pays for the completion of the improvements, it can be allowed the cost of doing so as damages if the cost is determined by the court to be reasonable.113 Presumably, this would be in addition to other elements of damages described above. Similarly, the creditor in Kidd completed construction and the court viewed the cost of doing so as probative of that portion of the creditor’s damages.114 In both cases, the courts viewed costs incurred after the creditor took title to the property (in one case by purchase from the borrower’s trustee in bankruptcy and in the other by foreclosure) as includable in the damage award.115 Almost all the other early cases with similar facts reached a comparable result.116

The more modern cases are in accord. In both Black v. O’Haver and Jetero v. BankAmerica, the lender completed the improvements and was awarded the cost of doing so.117 In Glendale Federal, the improvements were never completed and, in 1633 Associates and Chase Manhattan v. American National, the lenders were denied any recovery on their guaranties for unrelated reasons.118

2. Adjustments to the Base Measure of Damages

The courts have considered various factors in determining what, if any adjustments, to the base amount of damages are appropriate in arriving at a final damages award to the lender. Those factors are discussed in this part.

a. Amount of Loan Balance vs. Value of Property

It goes without saying that a lender’s damages under a completion guaranty cannot exceed the amount necessary to pay the outstanding balance of the lender’s loan and courts have so held.119 Consistent with that principle, if the value of the property with the uncompleted improvements is greater than the loan balance, the lender has no right to recover any damages under the completion guaranty.120 A lender might argue that, in setting its loan amount, it bargained for a loan-to-value ratio giving it a value cushion over and above the loan amount and that it has a right to have that cushion protected. A counterargument is that the failure to timely complete the project should be an event of default on the loan and that the lender should foreclose and realize the value of the property in that way, in which case preservation of a loan-to-value ratio is inappropriate. Trainor Co. provides some support for the lender’s argument at least where the lender is not able to foreclose immediately.

b. Unadvanced Portion of Loan Proceeds

Courts that consider the question of unadvanced loan proceeds sometimes state that the unadvanced principal amount of the lender’s loan should be deducted in calculating the lender’s damages.121 This seems appropriate in that the lender’s basic bargain was that it would lend the full contemplated loan amount in return for receiving the completed project as its collateral.

c. Delay Damages

The United States Supreme Court, in Prudence Co. v. Fidelity & Deposit Co. of Maryland,122 recognized that, if the cost to complete and correct defects is used as part of the evidence of difference in value, to give the lender “nothing but the cost of doing the unfinished work, plus the loss resulting from omissions and substitutions, would be a scant measure of reparation, allowing nothing for delay.”123 It held that the carry costs of the project must be included in the damage calculation and stated that “the reduction in value as the consequence of delay would be made up of two factors[:] the estimated cost of finishing the work, and the estimated carrying charges, not to exceed the rental value, during the period of idleness.”124

Any appraisal evidence of the value difference would likewise need to take into account the carry costs during the relevant period of delay resulting from the failure to timely complete the project because any buyer of the property would take those costs into account in deciding how much it would be willing to pay for the incomplete property as of the date of the default.

One might wonder why the Prudence Co. court limited the amount of carry costs to the rental value of the property. Presumably, that is because the case involved a hotel and, had the project been completed, it would only have generated the rental value and would have left the owner to cover any carry costs in excess of that amount. That limitation might not translate to another type of property, but the principle that carry costs during the period of delay should be limited based on the amount of economic benefit that could have been derived from the completed improvements during the relevant period seems appropriate where the guaranty is a bare guaranty of completion by a set date, as was typical of the early cases. However, there does not appear to be any reason that it should not be possible to draft a guaranty that expressly guarantees carry costs for a specified period without such a limitation.

The court in New Amsterdam Casualty Co. v. Bettes stated that damages “might reasonably include a reasonable rental value of the premises for a reasonable length of time,” but found the proof of such damages was inadequate in the case before it.125

d. Foreclosure by Lender

The lender’s foreclosure on the property can affect the outcome of a claim on a completion guaranty in several ways.126

The amount of the successful bid at the foreclosure sale can be evidence of the value of the property, but it is not conclusive because, among other things, the foreclosure sale does not take place at the same time as that at which the difference in value between the completed and the incomplete project is to be determined—the date of breach of the obligation to complete.127

Courts have held that, where the lender unreasonably delays foreclosure in a declining market, the guarantor cannot be charged with the decline.128

When the lender forecloses and obtains a deficiency judgment, damages under the completion guaranty cannot exceed the amount of the deficiency judgment because the lender is deemed to have been paid the amount realized at the sale.129 This is an application of the rule that the amount owing under a guaranty is generally limited by the amount of the underlying debt. In such a situation, the guarantor is protected by the well-known and widely-varying state law limitations on the award of deficiency judgments applicable to guarantors generally.

e. Profit or Loss on Ultimate Sale by Lender

In Mechanics’ Trust Co. v. Fidelity & Casualty Co. of New York,130 the court considered a situation in which the lender took title to the property, completed the improvements, and sold the property on installment contracts.131 The trial court admitted testimony to the effect that, if the installment contracts paid off, the lender would make a profit over and above the loan balance on resale of the property.132 The Pennsylvania Supreme Court held that it was appropriate to exclude the evidence of the potential profit, stating:

Obviously, appellant is not entitled to share in the profit realized on the dwellings following their completion by appellee. Whatever occurred after appellee became owner and had paid $9,851.34 to obtain what it was entitled to under the bond is of no moment to defendant. Defendant can claim no credit for the business acumen of plaintiff.133

f. Impossibility of Intended Use

Purdy involved an unusual situation in which neighboring property owners obtained an injunction restraining the borrower from operating a public garage on the property, which was the borrower’s intended use.134 The Pennsylvania Supreme Court held that the injunction did not relieve the guarantors of liability on their guaranty because it did not restrain the construction of the contemplated building, but only the use of the building as a public garage.135

g. Duty to Mitigate Damages

Of course, the nonbreaching party in an action for breach of contract cannot recover damages that it could have avoided by taking reasonable action to mitigate its damages.136

D. Liquidated Damages

As noted above, modern completion guaranties often contain provisions stating that the cost to complete is to be the measure of damages and that the difference in the value of the property in its incomplete state and with the improvements completed is not to be the measure. They often go on to recite that actual damages would be difficult to determine and the parties agree that the cost of completion is a reasonable estimate of the damages.137 Such recitals are, of course, intended to support an argument that the cost-to-complete measure is an enforceable liquidated damages provision.

The Restatement (Second) of Contracts sets out the general rule about the enforceability of liquidated damages provisions:

Damages for breach by either party may be liquidated in the agreement but only at an amount that is reasonable in the light of the anticipated or actual loss caused by the breach and the difficulties of proof of loss. A term fixing unreasonably large liquidated damages is unenforceable on grounds of public policy as a penalty.138

Although states’ expressions of their laws on the subject vary somewhat, they are generally consistent with the Restatement rule. New York’s highest court expressed that state’s law on liquidated damages as follows:

As a general matter parties are free to agree to a liquidated damages clause provided that the clause is neither unconscionable nor contrary to public policy. Liquidated damages that constitute a penalty, however, violate public policy, and are unenforceable. A provision which requires damages grossly disproportionate to the amount of actual damages provides for a penalty and is unenforceable.

Whether a provision in an agreement is an enforceable liquidation of damages or an unenforceable penalty is a question of law, giving due consideration to the nature of the contract and the circumstances. The burden is on the party seeking to avoid liquidated damages . . . to show that the stated liquidated damages are, in fact, a penalty. Where a party establishes a penalty, the proper recovery is the amount of actual damages established by the party.139

For commercial contracts, California law provides by statute that “a provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.”140

The Washington Supreme Court states its rule succinctly: “If the liquidated damages provision is either not a reasonable forecast or if the harm is easy to ascertain, then the provision is an unlawful penalty.”141

The Glendale Federal court, like the courts in a number of the older cases discussed above, ruled that the cost to complete is “competent, though not conclusive, evidence of the difference in value of the property with and without the improvements.”142 The court recognized that “[r]eproduction cost is one of three accepted approaches a valuation witness may consider in forming his opinion of market value in eminent domain proceedings.”143

The Restatement (Second) of Contracts takes the view that “the cost to complete is usually less than the loss in value.”144 Presumably, that is due to the fact that a buyer of the incomplete improvements would have to take the risk and inconvenience of completion into account, in addition to the cost, and would discount the amount it was willing to pay for the property accordingly.

Given the difficulty in proving the value of real property in litigation with dueling appraisal witnesses, even in the absence of the need to prove the difference in value between a property in a state of partial construction and its value if finished, it seems that using remaining cost to complete as liquidated damages is easily defensible in many, if not most, completion guaranty scenarios. That may not always be the case, however. For example, it may be very clear when the loan is made that the value of the property without the improvements exceeds the loan amount. In such a case, the lender may want to consider what obtaining a completion guaranty would accomplish and whether it is appropriate in structuring the loan. That kind of situation is apparent when the loan is made and is likely to lead to a court deciding that the cost of completion was not a reasonable estimate of the lender’s damages and, therefore, that a liquidated damages provision based on that cost is not enforceable. This kind of situation should be distinguished from situations in which the cost to complete is much greater than the loss in value, but where that difference could not reasonably have been anticipated at the time the guaranty was entered into.145 Examples of such situations could include the following cases:

  • When the project fails, it is evident that the improvements have become economically infeasible for one reason or another during the course of the loan. For example, the loan could be made to construct an apartment building in a small community where the bulk of local employment is at a single factory. If the factory owner makes a surprise announcement that the factory will be closed, the economics may no longer justify completing the project. In such a case, the lender is likely to regret not obtaining a full or partial repayment guaranty.
  • When the breach consists of defective rather than incomplete work, the cost to correct the defects may be out of all proportion to the effect of those defects on the value of the property.146 For example, the defective work may be in a location where a substantial amount of other work would need to be torn out to reach and correct the defects. The value loss due to the defects could be much less than the cost to correct them.

These types of facts may tempt a court to conclude that the cost to complete was not a reasonable estimate of likely damages at the time the loan was made; however, it is not clear that that would be true.

One can question whether a court should even apply a traditional liquidated damages analysis to a completion guaranty specifying the cost of completion as the amount of damages payable to the lender. Why is that? Suppose the lender of a ten million dollar construction loan, instead of obtaining a completion guaranty from the guarantor, obtains a repay-ment guaranty capped at two million dollars. A court would never have occasion to question whether the amount guaranteed was reasonable or the actual damages would be difficult to determine. Rather, it would enforce the guaranty up to the capped amount and subject to whatever antideficiency protections the applicable state’s law gives to guarantors generally. If instead of setting the cap at two million dollars, the parties set it at the cost to complete the improvements, why should a court delve into such issues or conclude that the guaranty should be limited to the difference in value between the incomplete and completed project if that is lower than the cost to complete?

V. Drafting Suggestions

This section proposes suggestions for the parties to consider when drafting or reviewing a completion guaranty. Initially, they should consider the scope of the risks to be addressed by guaranties in the transaction and what type of guaranty or guaranties best address those risks.

Given the uncertainty, as well as the likely cost and risks in enforcing a completion guaranty, the lender should consider whether such a guaranty is appropriate. If the lender can obtain a full repayment guaranty guaranteeing the entire loan amount, that is obviously better than a completion guaranty. The authors believe it is inadvisable for a lender to obtain a completion or carry guaranty from a guarantor that has also given a full repayment guaranty. In that situation, the repayment guaranty fully protects the lender’s interest, and the lender has no legitimate interest in completion of the project or the carry costs once its loan has been fully repaid. Introducing a complex completion guaranty in addition to a full repayment guaranty potentially creates ambiguity and an opening for the guarantor to argue that the full repayment guaranty does not mean what it says because otherwise there would be no function for the completion guaranty.

Even if the lender is unable to obtain a full repayment guaranty, a guaranty of a limited portion of the loan may be preferable to a completion guaranty in that it will be much easier to enforce. If the amount of such a partial guaranty is sufficient to address the likely risk that the improvements will not be completed, it may be a good alternative to a completion guaranty. That might be especially appropriate where the value of the unimproved land is high in comparison to the loan amount.

If the parties decide that a completion guaranty will be used, the following are some considerations in its drafting:

  • Obligations Guaranteed. A critical element is a clear statement of the obligations guaranteed.
    • The guaranty should guarantee that the improvements the lender is financing will be (i) completed, (ii) in a good and workmanlike manner, (iii) by the deadline required in the loan documents, (iv) without material deviation from the plans and specifications approved by the lender, (v) in compliance with applicable laws, regulations, building codes, etc., and (vi) free of liens other than any permitted by the loan documents.
    • The guarantor will want to make sure that the guaranty does not guarantee the completion of improvements that were not to be financed with the construction loan. In particular, lender drafts of completion guaranties sometimes extend to tenant improvements for leases in the property that the lender has not agreed to finance. Similarly, the lender will want to make sure that the completion obligation covers everything it agreed to finance. For example, if the loan is for the construction of a hotel and the acquisition of the related furniture, fixtures, and equipment, the completion guaranty should cover those items as well as construction of the building.
    • Construction loan agreements universally contain an obligation of the borrower to make deposits with the lender to cover cost overruns not anticipated in the approved project budget. This is typically referred to as an obligation to keep the loan “in balance.” The lender advances the balancing deposits to fund the project subject to the same conditions that apply to advances of loan proceeds and before further loan proceeds are advanced. The lender generally wants the guarantor to guarantee the borrower’s obligation to make these deposits.
    • The guaranty should have a clear standard for determining when completion has been achieved. This may require achievement of final completion including all punchlist items or it may require only substantial completion to the point that the property can be used for its contemplated income earning purposes. It should include issuance of a certificate of occupancy and usually includes certification by the project architect (and often the lender’s construction consultant) that the required state of completion has been reached.
    • The guaranty should be clear that once the loan has been repaid in full and the lender has no further obligation to advance loan funds, the guarantor’s obligation is satisfied. That will help to prevent a situation like the one that occurred in 1633 Associates v. Uris Buildings Corp., where the lender sought to enforce a completion guaranty after its loan was fully repaid by the winning bid at the lender’s foreclosure sale.147
    • The guaranty should cover the carry costs of the property during the period of any delay beyond the contractual completion deadline to the extent those costs are not paid from income of the property or other sources. If the lender intends the guarantor to guarantee carry costs for a period beyond completion (for example until a specified debt service coverage ratio is achieved), it may be better to provide for that in a separate carry guaranty. That will help make clear that the carry guaranty is separate from and in addition to the completion guaranty so that it is not limited by principles about how delay damages are calculated for guaranties that are limited to a completion obligation.
    • The guaranty should cover attorneys’ fees and other enforcement costs. Often completion guaranties cover these items only to the extent that they are incurred in enforcing the guaranty. The lender may want to consider having the guaranty cover all enforcement costs against the borrower and all guarantors until the guarantor has paid all amounts owing under the guaranty. Prior to that time, it is likely to be very difficult to separate the cost of enforcing the completion guaranty from other costs the lender incurs in enforcing its rights under the loan documents.
    • The guaranty should expressly provide that the damages recoverable by the lender will be reduced by the amount of the undisbursed loan proceeds allocated to construction and carry costs covered by the guaranty.
  • Remedies. The parties should carefully consider what remedies are appropriate.
    • Construction lenders often want to make clear that they can recover damages in the amount of the cost to complete construction and not in the amount of the difference between the value of the incomplete project and the value of the completed project. If that is the lender’s goal, the guaranty should be clear that the cost to complete includes any cost overruns and additional costs due to cessation of construction. It should also be clear that the cost to complete is not the entire amount of damages the lender is entitled to recover. Additional elements of damages should include carry costs for the period of delay and enforcement costs.
    • The cost-to-complete measure of damages should be expressed in the context of an appropriate liquidated damages provision in which the parties agree that the actual damages would be difficult to determine and that the cost to complete is a reasonable estimate of the applicable portion of actual damages (absent facts clearly indicating that these recitals are incorrect).
    • The guaranty should allow the lender to complete construction itself or through a court-appointed receiver. The lender should be authorized to recover amounts the lender advances to a receiver to fund completion. The guaranty should allow the lender to make revisions to the plans and specifications and the scope of the project without impairing the guaranty. It should exculpate the lender from errors of judgment to the extent they do not rise to the level of gross negligence or intentional misconduct.
    • The lender should carefully consider whether it wants to include as a remedy the ability to demand that the guarantor complete construction itself. Some of the complications in demanding that a guarantor complete a construction project are discussed in Part III.E of this Article. It may well be better to recognize that such a remedy is highly unlikely to be enforceable by an injunction for specific performance and to omit this remedy from the guaranty. Doing so will avoid often time-consuming negotiation over the specifics of how such a remedy would work in practice and over the guarantor’s ability to draw down previously undisbursed loan proceeds. In any case, the lender will want the guaranty to be very clear that the guarantor has no right to take over completion of the project absent the lender’s demand that it do so.
    • If the right to demand that the guarantor complete the project is included, the lender will want to make sure that any amount it advances to the guarantor from the loan can be added to the loan balance and, vitally, be secured by the lender’s mortgage. This may require approval by the borrower and, if the borrower is in bankruptcy, the bankruptcy court. The lender will also want to make sure that the guarantor proceeds under the requirements of the loan documents as it completes construction, including a new deadline for the guarantor’s completion of the project. The guarantor will want assurance that the lender will not foreclose on the project before an appropriate new completion deadline. Both parties will want clarity on when the guarantor has to meet the conditions to the lender’s requirement to make further advances such as curing certain existing defaults of the borrower in addition to its failure to complete.

VI. Conclusion

With the dearth of case law on completion guaranties in modern construction finance transactions and the complicated nature of the subjects addressed in these guaranties, it is important that they be carefully drafted to address the lender’s risks from failure to timely complete construction and the guarantor’s risks from a guaranty that guarantees obligations beyond those intended by the guarantor.

The sample form of the key portion of a completion guaranty attached to this Article attempts to balance the parties’ risks and interests and to provide a clear statement of what the guaranty covers.


Sample Key Provisions of Completion Guaranty148

1. Guaranteed Obligations; Remedies. Guarantor agrees as follows:

1.1 Guaranteed Obligations. Guarantor hereby absolutely and unconditionally guarantees to and for the benefit of Lender all Borrower’s obligations under the Loan Documents to the extent they require Borrower: (a) to achieve final completion of construction and installation all of the Improvements (including but not limited to the acquisition and installation of all personal property and fixtures included in the Plans and Specifications or the Budget) by the date required in the Loan Documents (the “Completion Deadline”), free and clear of all Liens (other than Permitted Encumbrances) and in accordance in all material respects with the Plans and Specifications (including all change orders approved, or deemed approved, by Lender), the Loan Agreement, the other Loan Documents, the Project Documents and Applicable Law (such completion and installation, “Lien-Free Completion”); and (b) to timely pay all hard and soft costs of achieving Lien-Free Completion including but not limited to (but without duplication) any and all (i) costs of such change orders, (ii) cost overruns, (iii) amounts necessary to satisfy or obtain the release of all Liens on the Property other than Permitted Encumbrances, and (iv) Balancing Deposits required in order to keep the Loan In-Balance (collectively, “Construction Completion Costs”). The obligations described in this paragraph are referred to in this Guaranty as the “Guaranteed Obligations.” [**Add if any tenant improvements are included in the Budget: As used in this Guaranty, notwithstanding anything to the contrary, the term “Improvements” includes all tenant improvements for space leased or to be leased to tenants under Leases (including replacement tenants for any tenants whose Leases are terminated prior to completion of tenant improvements for their leased space) to the extent, and up to the dollar amount, included in the Budget even if those tenant improvements are not described in the Plans and Specifications.**]

1.2 Lien-Free Completion. Lien-Free Completion will be deemed to have occurred only upon: (a) (i) Lender’s receipt of a written statement or certificate executed by Architect, and concurred in by Lender’s Construction Consultant in writing, certifying, without material qualification or exception, that the Improvements are fully completed and installed in accordance with the Project Documents and Applicable Law; (ii) Lender’s receipt of true and correct copies of all required certificates of occupancy and other appropriate governmental approvals and permits for all of the Improvements issued by the local government agency having jurisdiction and authority to issue the same; and (iii) expiration of the statutory periods within which valid construction Liens may be recorded and served by reason of the design, supply, or construction of the Improvements with any such Liens that have been filed having been released or discharged of record, or, alternatively, Lender’s receipt of valid, unconditional final Lien Releases thereof from all Persons entitled to record such Liens; or (b) Lender’s receipt of such other evidence of Lien-free Completion as Lender deems satisfactory in its sole discretion exercised in good faith.

1.3 Remedies. If the Guaranteed Obligations are not timely performed and paid, Lender will have the following remedies in addition to all other remedies available to Lender under this Guaranty, the other Loan Documents and Applicable Law:

(a) Completion by Lender. At Lender’s option, and without any obligation to do so, Lender may proceed (itself or through such agents, contractors, design professionals, material suppliers, and/or court-appointed receivers as it may select) to perform and pay all or any part of the Guaranteed Obligations (including all changes made to the Plans and Specifications by Lender in its sole discretion exercised in good faith) and Guarantor will, upon demand and whether or not construction is actually completed by Lender, pay to Lender, at any time and from time to time, all amounts expended by Lender in performing such obligations and all other damages Lender incurs as a result of Borrower’s failure to complete the construction and installation of the Improvements. To the extent that Lender elects to proceed under this Section 1.3(a), Lender may do so before or after foreclosure on the Property or without foreclosing. In any such case, Guarantor shall pay to Lender at any time and from time to time upon demand (to be applied on account of the Guaranteed Obligations) all costs and expenses incurred by Lender in so proceeding without any requirement that Lender demonstrate that the Property provides inadequate security for the Loan, that Lender has currently suffered any loss, or that Lender has otherwise exercised (to any degree) or exhausted any of Lender’s rights or remedies with respect to Borrower, the Property, any other collateral for the Loan or any other guaranty. If Lender elects to proceed under this subsection 1.3(a), Lender will have no liability for any errors or omissions in connection therewith (whether of Lender, its agents or contractors, or any receiver) in the absence of gross negligence or intentional misconduct by Lender.

(b) Damages. Whether or not Lender elects to proceed under any other subsection of this Section 1.3, Lender will have an immediate right to recover damages from Guarantor for failure of the Guaranteed Obligations to be fully and timely performed and paid. Such damages will, without duplication, be in the amount of the Net Damages Amount. As used in this subsection 1.3(b), the following terms have the following meanings:

“Net Damages Amount” means (i) the sum of the Completion Damages Amount and the Delay Damages Amount, minus (ii) the undisbursed principal amount of the Loan that was allocated to costs of constructing the Improvements or other amounts included in the Guaranteed Obligations, but excluding portions of such principal amount allocated to other purposes.

“Completion Damages Amount” means all Construction Completion Costs, as estimated by Lender’s Construction Consultant in its reasonable discretion (including any and all cost increases occurring prior to the time all of Guarantor’s obligations under this Guaranty have been satisfied), regardless of whether any or all of the Improvements are actually completed or any or all of the Construction Completion Costs are actually incurred.

“Delay Damages Amount” means (i) the sum of all Carry Costs for the Delay Period as estimated by Lender in its reasonable discretion; minus (ii) the amount of any Carry Costs for the Delay Period actually paid from income received from the Property, or otherwise actually paid by Borrower or Guarantor, prior to the date of the applicable determination of the Net Damages Amount; and minus (iii) the amount of any income from the Property actually applied to principal (but not interest or fees) on the Loan during the Delay Period.

“Carry Costs” means all costs and expenses of owning, managing, maintaining, operating, and financing the Property, including but not limited to interest and fees on the Loan, property taxes, assessments, insurance premiums, utility costs (including but not limited to electricity, water, heat, sewer charges and waste removal), management fees, security costs, [ground rents] and maintenance expenses.

“Delay Period” means the period of time from the Completion Deadline through the earlier of (i) the date Lien-Free Completion is actually achieved and (ii) the date Lien-Free Completion could reasonably be expected to have been achieved had Lender proceeded under subsection 1.3(a) of this Guaranty including any time reasonably necessary for Lender to obtain control of the Property in order to proceed with construction of the Improvements, as estimated by Lender in its reasonable discretion.149

Lender may commence a lawsuit to recover the Net Damages Amount without first demanding that Guarantor perform any of its obligations to complete and install the Improvements. Lender need not perform any work on the Improvements before commencing such a lawsuit. Under no circumstances will Lender have any obligation to require that Guarantor commence or complete any work on the Improvements or any obligation to accept any offer of performance by Guarantor to perform work on the Improvements at any time, and no such offer will under any circumstances constitute a defense to Lender’s claim for damages against Guarantor.


[**(c) Completion by Guarantor; Use of Loan Proceeds. Within [five] days from the date Lender notifies Guarantor of the occurrence of an Event of Default, Guarantor, at Guarantor’s sole cost and expense, shall if so directed by Lender in writing in Lender’s sole and absolute discretion, commence and diligently pursue completion of construction and installation of the Improvements to achieve Lien-Free Completion by the Completion Deadline (as the same may be extended by Lender in writing and in Lender’s reasonable discretion in connection with such demand). If Lender requires Guarantor to complete the construction of the Improvements, and Guarantor timely performs the Guaranteed Obligations, Lender shall make advances of the remaining Loan Proceeds to or for the benefit of Guarantor in the same manner in which, for the same purposes for which, and on the same terms and conditions upon which Lender would make such advances to Borrower under the Loan Agreement, so long as: (i) there is no default under this Guaranty; (ii) Guarantor cures all existing Events of Default, other than non-monetary Events of Default that are personal to Borrower and cannot be cured by Guarantor; (iii) all other conditions of the Loan Documents to the disbursement of Loan Proceeds are satisfied; (iv) Borrower is not a debtor in any bankruptcy or other insolvency proceeding or the court in such proceeding has entered a nonappealable final order authorizing Guarantor to complete the Improvements and providing that all Loan Proceeds disbursed to or for the benefit of Guarantor are for the account of Borrower, may be added to the outstanding principal balance of the Loan, and will be secured by the Mortgage;150 (v) Guarantor has legal right of access to the Property and the right to perform its obligations under this Section 1.3(c); and (vi) Borrower and each other guarantor of the Loan provide Lender with their written consent to such disbursements and to Guarantor assuming responsibility for completing the Improvements and their written agreement that all Loan Proceeds disbursed to or for the benefit of Guarantor are for the account of Borrower, may be added to the outstanding principal balance of the Loan, and will be secured by the Mortgage. If Guarantor does not satisfy all conditions to Lender’s obligation to begin further advances of Loan Proceeds set forth in the preceding sentence within 30 days after Lender demands that Guarantor complete the Improvements, Lender’s obligation to make such advances to Guarantor will be permanently terminated without in any way reducing Guarantor’s obligations under this Guaranty.**]151

1.4 Certain Changes. No change order or other change in the Plans and Specifications, the Budget, or the Project Documents made by Borrower (or by Lender pursuant to Section 1.3(a) of this Guaranty), whether with or without notice to or further consent of Guarantor and whether or not it increases Guarantor’s liability under this Guaranty, will relieve Guarantor of its obligations under this Guaranty or reduce such obligations and the Guaranteed Obligations will include the guarantee of all increased costs resulting from such changes.

1.5 Discretion. Wherever this Guaranty provides that an estimate or determination is to be made by Lender or Lender’s Construction Consultant in its reasonable discretion, that estimate or determination will be deemed reasonable if it is made in good faith and without manifest error.

1.6 Interest. All amounts owing by Guarantor under this Guaranty will bear interest at the highest rate applicable to the principal balance of the Loan as such rate is adjusted from time to time as provided in the Loan Documents.

1.7 Enforcement Costs. Guarantor shall pay all attorneys’ fees and costs and other costs and expenses incurred by Lender in enforcing any and all of its rights and remedies under this Guaranty and the other Loan Documents against all parties thereto through the date that Guarantor has satisfied all Guarantor’s other obligations under this Guaranty.

1.8 Guarantor’s Option to Pay Loan Balance. Notwithstanding anything to the contrary, Guarantor may, at any time after Lender’s obligation to make advances of Loan Proceeds has permanently terminated, satisfy all Guarantor’s obligations under this Guaranty by paying to Lender in immediately available funds all amounts secured by the Mortgage and all other obligations of Borrower under the Loan Documents.


1. See Thomas Hanahan, Reconsidering Completion Guaranties, 25 Prac. Real Est. Law. 21, 21–22 (2009).

2. See id. at 22.

3. See id.

4. See id.

5. See id.

6. Sometimes lenders allow a portion of this equity requirement to be paid with a “mezzanine loan.” The typical mezzanine loan structure involves the mezzanine lender making a loan to a special-purpose, bankruptcy-remote limited liability company that owns all the membership interests in the project-owner that is the borrower of the construction loan. See Andrew R. Berman, Risks and Realities of Mezzanine Loans, 70 Mo. L. Rev. 993, 998–1000 (2007). The mezzanine loan is secured by the mezzanine borrower’s membership interests in the project-owner so that the mezzanine lender and the construction lender do not have the same borrower or the same collateral. See id. If the construction lender allows a mezzanine loan, there will be an intercreditor agreement between the two lenders with detailed provisions governing the permitted terms of the mezzanine loan, foreclosure by the mezzanine lender on the membership interests in the project-owner, the mezzanine lender’s rights to cure defaults on the construction loan, etc. See id. at 1018–22.

7. See Hanahan, supra note 1, at 22.

8. If the lender has a full repayment guaranty guaranteeing the entire loan, a completion guaranty adds nothing because, if the loan is repaid in full, the lender has no further interest in completion of the project, and it is much easier to enforce a payment guaranty than a completion guaranty. However, in the absence of a satisfactory full repayment guaranty, the lender can require a completion guaranty from a creditworthy party as a backstop in case all the above safeguards fail to result in timely and proper completion of the project.

9. The lender should be careful not to agree to a provision saying that the guarantor’s obligations are released once all the borrower’s obligations under the loan documents have been satisfied. Such a provision, if not very carefully drafted, could be interpreted to mean that, if the lender has no further recourse to the borrower for repayment of the loan, the guarantor also has no further obligations under the guaranty. This interpretation would deprive the lender of recourse against the guarantor after a foreclosure under a foreclosure statute that denies the lender a deficiency judgment against the borrower after foreclosure, but permits one against the guarantor where the foreclosure sale proceeds are insufficient to fully repay the secured debt. For examples of such statutes, see Black v. O’Haver, 567 F.2d 361 (10th Cir. 1977) (interpreting Okla. Stat. tit. 12, § 686); Talbott v. Huswit, 78 Cal. Rptr. 3d 703 (Ct. App. 2008) (interpreting Cal. Civ. Proc. Code § 580a); Wash. Rev. Code § 61.24.100. All state statutory citations in this Article refer to the current statute unless otherwise indicated.

10. For purposes of this Article, “mortgage” refers to any form of mortgage, deed of trust, deed to secure debt, or other real property security instrument used to secure the construction loan.

11. This is distinguished from the case of a performance bond provided by the general contractor and issued by a professional bonding company that is unaffiliated with either the borrower or the contractor.

12. See Patricia J. Frobes & Joseph L. Coleman, Drafting Completion Guaranties (with Form), 11 Prac. Real Est. Law. 11, 15 (1995); see also Thomas Monahan, Reconsidering Completion Guaranties, 25 Prac. Real Est. Law. 21, 27 (2009).

13. See Hanahan, supra note 1, at 27.

14. See generally David A. Weissmann, Construction Lending: From the Ground Up (with form), 22 Prac. Real Est. Law 19, 26 (2006) (explaining that substantial completion leaves punchlist items undone).

15. See Hanahan, supra note 1, at 27–28.

16. See id.

17. There appear to be only five such reported cases that deal with completion guaranties. Each is discussed in Part IV.B of this Article. A sixth case dealing with a completion guaranty in a very large loan to finance a Las Vegas resort casino is so fact-specific that it has little general application. See Turnberry Residential Ltd. Partner, L.P. v. Wilmington Tr. F.S.B., 950 N.Y.S.2d 362 (App. Div. 2012).

18. See, e.g., Glendale Fed. Sav. & Loan Ass’n v. Marina View Heights Dev. Co., 135 Cal. Rptr. 802, 814–16 (Ct. App. 1977); 1633 Assocs. v. Uris Bldgs. Corp., 414 N.Y.S.2d 125, 128 (App. Div. 1979); Kidd v. McCormick, 83 N.Y. 391, 395 (1881).

19. See, e.g., 25 Samuel Williston & Pichard A. Lord, Williston on Contracts §§ 67:8, 67:100–67:104 (4th ed. 1990); DVD Copy Control Ass’n v. Kaleidescape, Inc., 97 Cal. Rptr. 3d 856, 879 (2009); Cohen v. CASSM Realty Corp., 39 N.Y.S.3d 597, 618 (2016); Crafts v. Pitts, 162 P.3d 382, 385 (Wash. 2007).

20. 99 P.2d 932 (Wash. 1940).

21. Id. at 933.

22. See id.

23. Id.

24. See 25 Williston & Lord, supra note 19, § 67:12 and cases cited therein.

25. See 25 Williston & Lord, supra note 19.

26. See id.

27. See id. at 810–11.

28. Id. at 811.

29. Id. at 832.

30. See id. at 811–12.

31. See id. at 812.

32. See id. at 814.

33. Id.

34. Id. at 816.

35. Id. at 814–15 (citations and internal quotation marks omitted). Glendale Federal argued that, because it bought the mortgaged property at its foreclosure sale, the measure of damages applicable to owners should apply, rather than that applicable to lenders, an argument the court dismissed. See id. at 815–16.

36. Id. at 814–16 (citations omitted). In reaching this conclusion, the Glendale Federal court cited Prudence Co. v. Fidelity & Deposit Co. of Maryland, 297 U.S. 198 (1936), amended by 298 U.S. 642 (1936), and Trainor Co. v. Aetna Casualty & Surety Co., 290 U.S. 47 (1933). The Prudence Co. and Trainor Co. cases are two United States Supreme Court cases from the era of the Great Depression, which are representative of a number of early cases involving performance bonds issued by surety companies, rather than the more modern type of completion guaranty. Earlier cases will be discussed in more detail in Part IV.C of this Article.

37. See Glendale Fed. Sav. & Loan Ass’n, 135 Cal. Rptr. at 814–15.

38. See id. at 817–18.

39. 567 F.2d 361 (10th Cir. 1977).

40. See id. at 364.

41. See id. at 365.

42. See id. at 371.

43. See id.

44. See id. at 366.

45. See id.

46. See id. at 371.

47. See id. at 371–72.

48. See id. at 366.

49. 414 N.Y.S.2d 125 (App. Div. 1979).

50. See id. at 125.

51. See id. at 126.

52. See id. at 126–27.

53. Id. at 128.

54. See id.

55. See id.

56. See id. at 127–28.

57. 1984 Tenn. Ct. App. LEXIS 3085 (1984), amended on rehearing, 1984 Tenn. Ct. App. LEXIS 3372 (1984).

58. Jetero, 1984 Tenn. Ct. App. LEXIS 3085 at *45.

59. Id. at *50.

60. See id. at *2.

61. See id. at *35.

62. See id. at *51–52.

63. See id. at *53–54.

64. See id.

65. 93 F.3d 1064 (2d Cir. 1996).

66. See id. at 1067.

67. See id. at 1073.

68. Id. at 1074 n.3 (emphasis added by the court).

69. See id. at 1069.

70. See id.

71. See id.

72. See id.

73. Id. at 1074.

74. Id. at 1073.

75. See id.

76. See, e.g., Prudence Co. v. Fid. & Deposit Co. of Md., 297 U.S. 198 (1936), amended 298 U.S. 642 (1936); Trainor Co. v. Aetna Cas. & Sur. Co., 62 F.2d 487 (3d Cir. 1932), rev’d on unrelated grounds, aff’d., 290 U.S. 47 (1933); Province Sec. Corp. v. Md. Cas. Co., 168 N.E. 252 (Mass. 1929); Westcott v. Fid. & Deposit Co. of Md., 84 N.Y.S. 731 (App. Div. 1903); Purdy v. Massey, 159 A. 545 (Pa. 1932); Crump & Trevezant, Inc. v. Cont’l Cas. Co., 55 S.W.2d 762 (Tenn. 1933); New Amsterdam Cas. Co. v. Bettes, 407 S.W.2d 307 (Tex. App. 1966).

77. See, e.g., Phillippe v. Curran, 218 Ill. App. 517 (App. Ct. 1920); Norway Plains Sav. Bank v. Moors, 134 Mass. 129 (1883); Longfellow v. McGregor, 63 N.W. 1032 (Minn. 1895); United Real-Estate Co. v. McDonald, 41 S.W. 913 (Mo. 1897); Kidd v. McCormick, 83 N.Y. 391 (1881); W. Const. Co. v. Austin, 99 P.2d 932 (Wash. 1940).

78. See, e.g., Prudence Co., 297 U.S. at 204 (“to construct and pay for a building conforming to the contract, and complete it by the stated time”); Trainor Co., 62 F.2d at 488 (“within ten months from the date hereof each of the lots or premises . . . shall be fully improved and completed with a building, together with the other improvements (such as paved streets, sidewalks, driveways, gas, water, sewerage, etc.), in keeping with and as shown by the aforesaid Plans, Specifications, and Conditions, Building Plats and Surveys”); United Real-Estate Co., 41 S.W. at 914 (“to erect upon said property ten (10) two or three-story brick and stone buildings at a cost of not less than thirty-five thousand ($35,000) dollars, and to have the said buildings completed, and all the labor and materials entering thereinto paid for, on or before June 28, 1893”); Kidd, 83 N.Y. at 391 (“to erect a dwelling on each lot”); Purdy, 159 A. at 546 (“complete the building mentioned free and clear of mechanics’ liens or claims”).

79. See, e.g., Prudence Co., 297 U.S. at 205–07 (by implication); Phillippe, 218 Ill. App. at 524–25; Province, 168 N.E. at 257; Norway Plains Sav. Bank, 134 Mass. at 130; Longfellow, 63 N.W. at 1034; United Real-Estate Co., 41 S.W. at 914; Kidd, 83 N.Y. at 395; New Amsterdam Cas. Co., 407 S.W.2d at 315.

80. See, e.g., Norway Plains, 134 Mass. at 135.

81. See, e.g., Purdy, 159 A. at 547; Crump & Trevezant, Inc. v. Cont’l Cas. Co., 55 S.W.2d 762, 763–64 (Tenn. 1933).

82. 159 A. 545 (Pa. 1932).

83. See id. at 549.

84. See Crump & Trevezant, Inc., 55 S.W.2d at 762.

85. See id. at 763; Purdy, 159 A. at 546.

86. Purdy, 159 A. at 546–47.

87. Trainor Co. v. Aetna Cas. & Sur. Co., 49 F.2d 769, 773 (E.D. Pa. 1931), aff’d, 62 F.2d 482 (3d Cir. 1932), rev’d, 290 U.S. 47 (1933).

88. Trainor Co., 290 U.S. at 55.

89. Purdy, 159 A. at 548–49.

90. See Glendale Fed. Sav & Loan Assn. v. Marina View Heights Dev. Co., 135 Cal. Rptr. 802 (Ct. App. 1977).

91. Purdy, 159 A. at 547.

92. Mechs.’ Tr. Co. v. Fid. & Cas. Co. of N.Y., 156 A. 146, 148–49 (Pa. 1931) (emphasis added).

93. See Purdy, 159 A. at 546.

94. 49 F.2d 769 (E.D. Pa. 1931), aff’d, 62 F.2d 482 (3rd Cir. 1932), rev’d, 290 U.S. 47 (1933).

95. See Trainor Co., 290 U.S. at 52.

96. See id.

97. See id.

98. See id.

99. See id. at 53.

100. See Trainer Co. v. Aetna Cas. & Sur. Co., 62 F.2d 482, 489 (3d Cir. 1932). All of the Trainor Co. opinions were rendered before the Supreme Court’s decision in Erie Railroad Co. v. Tompkins, 304 U.S. 64 (1938), which famously held that federal courts sitting in diversity do not have the power to create general federal common law when hearing state law claims, but must apply state law.

101. Trainor Co., 62 F.2d at 488–89.

102. Trainor Co., 290 U.S. at 53–54 (emphasis added).

103. See id. at 55–56.

104. See id.

105. 83 N.Y. 391 (1881).

106. Id. at 397–98 (emphasis added).

107. The court in New Amsterdam Casualty Co. v. Bettes, 407 S.W.2d 307 (Tex. App. 1966) held that cost to complete is the “main guide in determining the chief element of the damage, although it may not always be conclusive” (quoting Annotation, Construction and Effect of Bond or Other Agreement to Protect Mortgagee Against Prior Tax or Other Liens, or Failure to Make or Complete Improvements or Repairs, and Measure of Damages for Breach Thereof, 103 A.L.R. 1396, 1397).

108. 297 U.S. 198, 205–06 (1936). The Prudence Co. case involved a construction loan on the famous Essex House hotel on Central Park South in Manhattan, whose residents have included both Igor Stravinsky and Casey Stengel. See Marriott, https://www.marriott.com/ hotels/travel/nycex-jw-marriott-essex-house-new-york/ [https://perma.cc/GTP7-YUJ8].

109. See Prudence Co., 297 U.S. at 205–06

110. 41 S.W. 913 (Mo. 1897).

111. Id. at 914.

112. 168 N.E. 252 (Mass. 1929).

113. See Mechs.’ Tr. Co. v. Fidelity & Cas. Co. of N.Y., 156 A. 146, 148–49 (Pa. 1931).

114. See Kidd v. McCormick, 83 N.Y. 391, 397 (1881).

115. See Mechs.’ Tr. Co., 156 A. at 148–49; Kidd, 83 N.Y. at 399.

116. See, e.g., Prudence Co. v. Fidelity & Deposit Co. of Md., 297 U.S. 198 (1936), amended 298 U.S. 642 (1936); Wheeler v. Equitable Tr. Co., 55 A. 1065 (Pa. 1903); Crump & Trevezant, Inc. v. Cont’l Cas. Co., 55 S.W.2d 762 (Tenn. 1933). Contra Province Sec. Corp. v. Md. Cas. Co., 168 N.E. 252 (Mass. 1929).

117. See supra Part IV.B (discussing cases).

118. See supra Part IV.B.

119. See, e.g., Trainor Co. v. Aetna Cas. & Sur. Co., 290 U.S. 47, 53–55 (1933); Norway Plains Sav. Bank v. Moors, 134 Mass. 129 (1883).

120. See, e.g., Province Sec. Corp., 168 N.E. at 252; Wheeler, 63 A. at 701 (finding that contract was one of indemnity rather than of guaranty).

121. See, e.g., Province Sec. Corp., 168 N.E. at 257.

122. 297 U.S. 198 (1936), amended, 298 U.S. 642 (1936).

123. Prudence Co., 297 U.S. at 206.

124. Id.

125. 407 S.W.2d 307, 319 (Tex. App. 1966).

126. See Annotation, Purchase of Mortgaged Property by Mortgagee as Affecting Liability on Bond Conditioned for Improvement of Property or Other Obligation Collateral to Mortgage and Mortgage Debt, 82 A.L.R. 762 (1933).

127. See Province Sec. Corp. v. Md. Cas. Co., 168 N.E. 252, 257–58 (Mass. 1929).

128. See Norway Plains Sav. Bank v. Moors, 134 Mass. 129, 136 (1883) (failing to address whether the guarantor can contractually waive the effect of such a delay).

129. See Westcott v. Fidelity & Deposit Co. of Md., 84 N.Y.S. 731, 733–35 (App. Div. 1903).

130. 156 A. 146 (Pa. 1931).

131. See id. at 147.

132. See id.

133. Id. at 149.

134. See Purdy v. Massey, 159 A. 545, 546 (Pa. 1932).

135. See id. at 295–96 (holding the bond to be one of guaranty, not of indemnity).

136. See Restatement (Second) of Contracts § 350 (Am. L. Inst. 1981); 24 Williston & Lord, Williston on Contracts § 64:31 (4th ed. 2018); see also Kidd v. McCormick, 83 N.Y. 391, 399 (1881) (viewing lender’s taking possession of project and completing construction as an appropriate attempt to mitigate its damages).

137. These provisions may or may not make clear that this is the measure of damages only for the failure to complete, as distinguished from the failure to complete by the required deadline, which implicates a different set of considerations, including carry costs for the period of the delay.

138. Restatement (Second) of Contracts § 356(1) (emphasis added); see also 24 Williston & Lord, Williston on Contracts § 65:1 (4th ed. 2018) (“because the goal of contract remedies is compensation, not punishment, if the purpose or effect of a provision stipulating damages is to punish the nonperformance of a party’s obligations under the agreement, or to coerce or secure performance of the agreement through the assessment of an unreasonable sum payable on nonperformance, the provision will not be upheld”).

139. Van Duzer Realty Corp. v. Globe Alumni Student Assistance Ass’n, 25 N.E.3d 952 (N.Y. 2014) (citations and internal quotation marks omitted).

140. Cal. Civ. Code § 1671(b). Subsection (d) of the same statute provides that, in consumer contracts, a liquidated damages clause is void except that the liquidated amount is entitled to a presumption that it reflects actual damages “when, from the nature of the case, it would be impracticable or extremely difficult to fix the actual damage.”

141. Minnick v. Clearwire U.S. LLC, 275 P.3d 1127, 1131 (Wash. 2012).

142. Glendale Fed. Sav. & Loan Ass’n v. Moving View Heights Dev. Co., 135 Cal. Rptr. 802, 830 (Ct. App. 1977).

143. Id. (citing Cal. Evid. Code § 820 (1967)). This is the familiar cost approach to real estate appraisal, the others being the sales comparison approach and the discounted future income approach. Appraisal Institute, Understanding the Appraisal, 6–7 (2013), https://www.appraisalinstitute.org/assets/1/7/understand_appraisal_1109_(1).pdf [https://perma.cc/RX4U-TFCN]. Appraisers typically analyze the property under appraisal using all three approaches and consider all of them in arriving at a final opinion of value. See id. at 7. Of course, it is highly unlikely that an appraiser could locate any comparable sales of properties in a like state of incompletion in order to apply the sales comparison approach in the usual way. See id.

144. Restatement (Second) of Contracts § 348 cmt. c (Am. L. Inst. 1981). The comment goes on to point out that the cost to complete can clearly be excessive in some situations such as, for example, some cases in which the breach consists of defective, rather than incomplete, work or materials. See id.

145. See id. § 351 cmt a.

146. See, e.g., id. § 348 cmt. c.

147. See supra note 9 for a discussion of the care required in drafting such a provision; see also 1633 Assoc. v. Uris Bldgs. Corp., 414 N.Y.S.2d 125 (App. Div. 1979).

148. These provisions use various capitalized terms. Those that are not defined in these provisions are self-explanatory and are commonly defined in construction loan agreements.

149. This guaranty covers only carry costs incurred due to delay in completion of the improvements. If the parties intend to cover carry costs for a longer period, such as the time needed to lease up the project and meet a financial milestone, this guaranty would need to be revised accordingly or a separate guaranty for the additional period could be used.

150. Note that the Mortgage should provide that all Loan Proceeds disbursed to or for the benefit of Guarantor are for the account of Borrower, may be added to the outstanding principal balance of the Loan, and will be secured by the Mortgage.

151. Clause 1.3(c) is bracketed to indicate that a lender should very seriously consider whether it wants to include this obviously problematic remedy.


Brian D. Hulse & Kevin Badgley

Brian D. Hulse is a partner with the Seattle office of Davis Wright Tremaine LLP. He focuses his practice on real estate finance, construction finance, commercial lending and transactions, loan workouts, and insolvency. He is a co-chair of the State Law Survey Task Force of the American Bar Association’s Commercial Finance Committee, for which he acted as editor, and author of the Washington chapter of the books Commercial Lending Law: A Jurisdiction-by-Jurisdiction Guide to U.S. and Canadian Law, and The Law of Guaranties: A Jurisdiction-by-Jurisdiction Guide to U.S. and Canadian Law, both published by the ABA. He is also a fellow and former regent of the American College of Commercial Finance Lawyers, a fellow of the American College of Mortgage Attorneys, and a member of the Legal Opinions Committee of the Washington State Bar Association. He can be reached at brianhulse@dwt.com. Kevin D. Badgley is an associate with the Seattle office of Davis Wright Tremaine LLP. His practice is concentrated in the areas of commercial real estate and finance. His finance practice includes representation of both lenders and borrowers in connection with real estate term loans, construction loans, and asset-based lending transactions. He also has extensive experience representing lenders in providing construction and permanent financing for multifamily residential projects that qualify for low-income housing tax credits and tax-exempt bond financing. He is a member of the Washington State Bar Association and the State Bar of Michigan. He can be reached at kevinbadgley@dwt.com.