Construction and Development Finance: thinking ahead

The chosen procurement structure for a development will ultimately drive the construction documents to be put in place, and there are varying options typically seen in the market, from design and build, traditional and construction management trade contracting.

Whilst most procurement structures are likely to be acceptable to lenders, if documented correctly, often design and build is viewed most favourably due to the single point of responsibility resting with the contractor for both design and construction – seen as mitigating a degree of risk.

Lenders, particularly for larger projects of value, will expect to see standard form build contracts put in place (e.g. JCT/SBCC), amended by way of a bespoke schedule of amendments enhancing the position of the borrower/developer as ‘Employer’ and passing greater risk and responsibility on to the contractor.

Often the terms of the build contract will be subject to lender approval and, therefore, it is key that the version of the schedule of amendments issued at tender stage is either approved by the lender (if timescales allow for such early engagement) or reflects a position reasonably expected by a typical development finance lender. Otherwise, it can be difficult to introduce lender requirements later with the chosen contractor.

Lenders typically expect to see bespoke forms of appointment used to appoint the professional team as opposed to those prepared by industry bodies (such as ICE, CIC or RIBA for example). These industry forms, unless significantly amended, are not on terms which meet typical lender requirements.

Lenders will again often look to approve the terms of professional team appointments and, therefore, it is prudent to ensure template forms are agreed with the lender prior to issue, if possible, or otherwise reflect a position reasonably expected by a typical development finance lender.

In agreeing the terms of any build contract and professional team appointment a developer should ensure to include provision for collateral warranties in favour of a range of potential beneficiaries, including any lender providing development finance (and refinance).

Forms of collateral warranty should be agreed in advance with the construction parties, be on terms consistent with the relevant underlying documents and also be appended for extraction and population in future.

Lenders will often look for collateral warranties from all core construction parties, including the contractor, the key professional team (such as design consultants as well as any project manager and contract administrator/employer’s agent) and any sub-contractors with material design responsibility.

All such collateral warranties are usually expected to include ‘step-in rights’ and so this should be provided for as an option in the template forms agreed with construction parties. For more information on step-in rights and the ranking of step-in rights, please see the following Brodies Insight: Collateral Warranties and Step-in Rights: where do you rank?

Often, in addition to collateral warranties, lenders will look to take security over a borrower’s rights in respect of core construction documents, including the build contract, professional team appointments as well as any performance security (such as any parent company guarantee and/or performance bond).

In agreeing the terms of any such documents, it is important to esure there is provision for assignment/assignation in security and also, where possible, that any such assignment/assignation in security to the lender (including re-assignment/assignation on redemption of the loan) does not count towards the number of available permitted assignations under the documents, which are often limited to two.

For developments of a more significant scale and value, lenders will often look to see performance security provided by the contractor in favour of the developer/borrower, such as a parent company guarantee and/or performance bond.

Any such requirements should be discussed with the lender in agreeing the terms sheet so that the required performance security can be tabled with, and priced by, the contractor at tender stage.

As noted above, lenders will often require security over any performance security and, therefore, this should be considered and provided for in agreeing the terms.

construction teamThe key construction insurances from the perspective of a lender are professional indemnity insurance (PII) and insurance of the works (known as ‘all risks’ insurance).

In terms of PII, lenders will look to see a level of cover which is appropriate to the nature of particular construction parties’ role (i.e. design or non-design) and the scale and value of the particular development project. Developers should ensure an appropriate level of PII is required under the terms of the build contract and professional team appointments, and that evidence of cover (e.g. by way of an insurance broker’s certificate) is obtained from construction parties at the outset and available to be delivered to the lender when required.

In addition to requirements around levels of PII, lenders often also require to be noted as ‘composite insured’ on all risks insurance policies, and at times also as ‘first loss payee’. Developers should ensure they understand the lender’s particular insurance requirements and that those requirements are obtainable, whether through its own policy of insurance or that of the contractor, depending on the insurance option applicable under the build contract.