Bank Builds New Retail Park
SOURCE: SCOTTISH BANKER, MARCH 2006
A bank would normally only fund a development, but if the borrower defaults, the bank may also have to build it!
A bank may be involved in a development of a property (new build and/or refurbishment) by providing finance to the developer, or to the end user or purchaser of the completed development. In each case, the bank will have an interest in ensuring that the development is successfully completed, as that will increase the value of the secured asset.
The developer will appoint a professional team to advise in connection with the design and construction of the development, and each such professional will have various contractual duties that will provide some protection to the developer that the development will be properly constructed.
However, what if the development is not properly constructed? This will adversely affect the value of the development, and therefore will reduce the value of the bank security. How can the bank manage that risk, and protect the value of its security?
One obvious route, is to ensure that the loan advanced is always less than the value of the development, and each drawdown request would be accompanied by a valuation certificate – this is a standard provision in most development facilities.
In addition, the bank should consider obtaining collateral warranties from the relevant members of the professional team. These warranties would effectively enable the bank to make a claim against the relevant professional whose wrongdoing has caused it to suffer loss, even though the bank had not appointed that professional. It is important to review any underlying construction contracts relating to the professional team as these will impact on the effectiveness of the collateral warranties obtained.
Another protection involves Step-in Rights - these are only used as a last resort. The purpose is to allow the bank to step-in to complete the development should the developer default, thus enabling the bank to protect the value of its asset. The bank will not be obliged to step-in (there may well be occasions where it would not be economic to do so), but will have the option to do so. Often the step-in right will be triggered by the developer defaulting under the main development agreement, and you need to ensure that the professional team are still obliged to perform if the step-in rights are exercised (without specific provisions, the professional team may have the option to terminate if the developer is in default). It may be that as well as a bank, a contracted purchaser of the completed development may also obtain step-in rights (it also having an interest in ensuring that the development is completed), and you would need to ensure that the ranking of these rights is agreed.
Therefore, if you are involved in the funding of a development, you need to consider what happens if the development does not go according to plan; and if you are relying mainly on the success of the development to secure the lend, you need to be satisfied with the form of the construction contracts in case the bank needs to rely on the collateral warranties, or step-in and actually build it out.
AUTHOR: ALEX INNES