Supreme Court Rules Financing Banks Must Compensate Buyers for Construction Delays

In a landmark ruling, the Supreme Court has established that when a financing bank chooses to step into the shoes of a collapsed contractor and complete a construction project, it cannot evade its obligations toward apartment buyers.

The ruling means that buyers are entitled to receive compensation for delivery delays out of the project funds—specifically from the liquidation pool—before the bank receives its share of the remaining funds.

Now, following the acceptance of the appellants' position by the Supreme Court, the District Court will be required to determine the precise compensation amount.

The case in question involved a contracting company that entered into an agreement with rights holders in a residential building in Bat Yam to execute building reinforcement work. In exchange for the work, the contracting company was granted construction rights allowing it to build 14 new housing units alongside the existing apartments.

The project was financed through a "financial accompaniment" model, using loans taken by the contracting company from lending institutions against collateral. Eventually, the contracting company defaulted on its loans. The lenders approached the court seeking to enforce the collateral, and a receiver was appointed after the court ordered that insolvency proceedings be initiated against the contractor.

The lending companies, through the receiver, chose to complete the project themselves based on the existing contract.

Previously, before running into difficulties, the contracting company had signed agreements with buyers who purchased one of the new apartments in the building. The agreement stipulated that the apartment delivery date would not exceed 24 months from the issuance of the building permit, and outlined compensation terms for delivery delays.

In practice, the apartment was not delivered to the appellants by the contractual deadline, and remains undelivered to this day, although other buyers received their apartments. Consequently, the buyers demanded payment of the agreed compensation.

Liabilities and Rights

The receiver argued that the obligation to deliver the apartment on time rested solely with the contracting company, which was the party to the sales agreement. He contended that his appointment stemmed from the lenders' request and that he undertook no additional commitments toward the apartment buyers.

In response, the buyers argued that once the receiver and the lending companies chose to uphold the sales agreements, they could not selectively rely on certain provisions while ignoring others, entering the contractor's shoes "for better and for worse."

They further asserted that the lending institutions, which accompanied the project from its inception, owed an enhanced duty of care. According to the buyers, the lenders—acting as "skilled institutional entities operating with discretion"—chose the optimal alternative for themselves and thus must assume the contractor's position and complete the project while honoring all associated liabilities.

Conversely, the lenders maintained that their commitment to the buyers was limited to providing guarantees in the event that buyers were left without an apartment or their invested capital.

The Supreme Court ruled that "when a bank acts in its capacity as a lender and project supervisor, and as long as the contractor remains an active party, the bank is not bound by the contractor's obligations under agreements with apartment buyers."

However, it was established that "in cases where the lending bank chooses to step into the shoes of the contractor and complete construction, its rights are generally subject to the apartment buyers' rights to compensation for delivery delays, establishing an order of priority for funds within the liquidation pool. Nonetheless, as the official receiver argued, this subordination—which does not constitute personal liability but rather a rule governing the order of liquidation—applies exclusively to the period of delay starting from the enforcement of collateral onwards, and not to prior dates."

"The lending bank's choice to continue the project in order to complete it while maintaining the contractual framework cannot be selective," the Supreme Court ruled. "The lending bank cannot choose to complete construction and avoid encashing guarantees while executing sales agreements with buyers and collecting full contractual consideration on one hand, while unilaterally altering the rights and obligations of buyers to their detriment on the other."

The court added that "permitting a lending bank or receiver to choose which contractual provisions to uphold and which to discard (such as delivering the apartment while evading compensation liabilities for delays) could severely harm the buyers."

Furthermore, the court noted that the respondents sought to disregard provisions ensuring buyers' entitlement to delay compensation. However, the apartment buyers never consented to such a modification in their sales agreements. Subject to the appellants fulfilling the necessary conditions under the sales agreement, they appear entitled to delay compensation.

The court also addressed the potential incentive structures created by such financial accompaniment arrangements. "Ruling that lending banks are subject to compensating apartment buyers for delays occurring during the project completion phase may impact banks' incentives to complete construction projects partway through guarantee redemptions," highlighting the possibility of negotiations between the parties to reach mutual agreements.