New technology has given rise to new avenues for direct connection between parties needing a service, and the parties who can provide that service. One of the fastest growing and brightest stars of this technology driven and efficient marketplace is Uber, the non-cab “cab” company that connects passengers to drivers. Friend-of-the-Construction Payment Blog Funding Gates recently posted an interesting article comparing Uber’s direct to “consumer” business model to the world of peer-to-peer (P2P) lending.
P2P Lending
P2P lending is defined by lending money to unrelated individuals without using a “traditional” financial institution intermediary, like a bank or credit union. Generally, this type of lending is accomplished with unsecured loans, which can, in turn, heighten the risk of default. To mitigate this risk of default, most lenders diversify their loans, either among many borrowers or by investing in portions of many loans. The unsecured nature of the loan still means that the lender will likely be left holding the bag in the event of a borrower default.
This type of lending can be advantageous to borrowing parties with good credit, as the interest rate set by the lenders (or by an intermediary company) through an evaluation and scoring of the potential borrower’s credit risk. Another benefit of the P2P lending model is that parties (and start-up or other young businesses) to whom traditional lending institutions may be hesitant to lend, are able to source lending despite this.
P2P, Construction, & Security Priorities
Security, and the ability to remain in a secured position is crucial to a thorough credit management policy for parties in the construction industry. Secured debt is much more likely to be paid, (and paid on-time), than unsecured debt, so the use of the security instruments available can pay real-world dividends to prudent CFMs. For construction industry participants, security rights are built directly into the fabric of every state’s laws in the form of mechanics liens.
When a significant default or financial mishap occurs on a construction project, a determination must occur not only separating the secured parties from the unsecured parties, but also ranking the secured parties by the priority of their encumbrance on the property. The general rule for determining priority is the “first in time, first in right” rule, which holds that the date of attachment (or, occasionally, date of recording) of a particular encumbrance determines its particular priority. However, it’s important to note that there can always be exceptions and/or modifications to this general rule.
For the purposes of mechanics lien priority, it is usually the case that the priority of a mechanics lien dates from the attachment of the lien, and, that the date of attachment of a mechanics lien on the project dates to the start of work. This leads to two results in most cases, in which no exceptions apply: 1) all mechanics liens on a project generally have the same priority, such that each valid mechanics lien recovers a pro rata share of the proceeds of a foreclosure action if there are not enough proceeds to pay each fully; and 2) the construction lender generally enjoys priority over the mechanics lien claimants on the project, if the construction lender secured the loan prior to the beginning of work on the project.
In the case of a potential construction project financed by P2P lending, however, this may not be the likely result. If the P2P loan was, like many such loans, unsecured, the mechanics lien claimants would be in an even better position in the event of borrower default. The lender would be unsecured, and only able to recover after the secured creditors of the defaulting party were paid. This is a significant development. While the risk of being an unsecured creditor is considered in these P2P lending agreements, and the risk is a factor in determining the interest rate charged, this may not be done with consideration of whether there are any secured parties that may also eventually make a claim against the borrower for work performed that was to be paid by the proceeds of the P2P loan. While being unsecured is never the best position, it is more risky when there are other secured parties that can take the first cut.