Construction: Developers and Finance - Striking a Balance
17 October 2019
When developers look to develop a project that requires bank funding, there are a number of issues that they must keep in mind. Appropriate project structuring and robust contract documentation are key. Developers must strike a balance between getting contracts closed out efficiently that reflect their own risk profile and do not unduly affect cost or programme, while ensuring that funder requirements are satisfied. It can be a challenging balancing act.
1. Early engagement / reflecting the contract structure
From the outset of any development, it is essential that bankable forms of design appointments and works contracts are issued at tender stage. All too often, professionals and contractors undertake work or services without being formally engaged on bankable terms which can reduce a developer’s bargaining position and ultimately lead to prolonged negotiations.
It is also imperative that the construction documents reflect the procurement and funding structure for the project. If the development is being procured by way of a forward-fund structure, then the underlying construction agreements need to reflect requirements that are consistent with the terms of the development agreement.
If the contract structure is not determined before the contracts are awarded then the contracts should facilitate flexibility. One common issue can arise when it is not known if the works will be procured on a ‘traditional’ structure or a ‘design build’ structure so there should be the ability to novate contracts to a design build contractor at a later stage.
2. Knowing what a funder will require
In practice, funders' views on whether specific terms are bankable can vary depending on the particulars of a construction project and their respective advisors’ opinions. Notwithstanding this, there are a number of key issues that funders focus on in their due diligence, including:
Price & programme certainty: Funders generally require price and programme certainty. In the context of construction contracts, the fixed price RIAI blue form of contract will be preferred over the yellow form, which is re-measurable, unless there is good reason for use of a yellow form.
Appropriate standard of performance: A funder will expect to see an appropriate standard of care that reflects the type of asset being developed and the contract structure.
Limitations of liability: Most design consultants and certain contractors require limitations of their liability to be included in their appointments. The market has fairly clear standards around these provisions, depending on the specific project and the nature of the contract being negotiated.
Collateral warranties: A funder will expect collateral warranties from the contractor and design team to include some important provisions, including warranties relating to performance, assignment, step-in and a warranty to maintain insurances.
Funders’ requirements often vary depending on who the funder is. Irish lenders often take different approaches to certain risk issues and foreign based lenders even more so – lenders’ differing approaches to net contribution clauses is a good example. Knowing who the funder is and being able to pre-empt positions that particular funders will take on issues can save a lot of time in finalising contracts.
Where development finance is required, it is important to have clarity on the contract structure from as early on as possible and to procure construction contracts which reflect not just the developer’s requirements but also the funder’s requirements. This is often difficult in practice to achieve, particularly where complex development and funding structures are involved.
Developers must tread a fine line between negotiating an appropriate transfer of risk between the developer and the contractor / consultants, and ensuring that the contract terms reflect where the market is on key lender issues. Getting that balance right is critical to successfully achieving financial close.
The content of this article is provided for information purposes only and does not constitute legal or other advice.