Vol 6 (2009) - Issue 3

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Beware the Pitfalls of Taking on an Insolvent Property Development

The last fifteen years have seen property values rising consistently. Lenders have felt comfortable providing finance to borrowers investing in property developments, because they have been confident that if the borrower defaulted, the underlying assets comprising their security would support full repayment.

Times change. The rapidly falling property market now means that lenders no longer have that security blanket. In today’s declining market, the underlying property development value may not be enough for the lender to be sure that it could be repaid in full from the proceeds of sale, and the borrower may not be able to provide covenants strong enough for the lender to consider a refinancing. There may not be buyers willing and able to take on a development that is half complete, and lenders may find themselves in a position where they have provided financing for a project that has shuddered to a halt, with the development partially completed and little or no hope of work continuing, while the underlying property value makes it unattractive to use the normal route of appointing a receiver and selling.

Increasingly then, lenders are being forced to consider different options. They may have to roll over loans notwithstanding breaches; they may have to allow a refinancing, albeit reluctantly. Or they may decide to mothball, or ‘landbank’ certain developments, keeping the underlying properties in their portfolio until the property market recovers. This means that they then have to manage the property in the downturn, and in some cases may have to act as corporate landlords. Or, in an effort to eradicate the negative value inherent in a half-built asset, they may decide to appoint an insolvency practitioner in the form of a fixed charge receiver or administrator to continue the development, in the hope that the finished development will ultimately be sold and their costs recovered. This option comes with risk, and requires extensive funding, the extent of which cannot be readily ascertained at the start.

This article will look at some of the issues a lender should consider in these circumstances.

Regulatory and environmental issues

When taking a development property onto its books, there are numerous regulatory issues a lender would need to investigate. Issues such as health and safety, fire safety, asbestos regulations, water safety, contaminated land, breach of planning notices and occupier’s liability, to mention just a few, may all prove problematic, and can prove potentially very expensive. Many come with strict liability imposed or with a limited due diligence defence, and some carry criminal sanctions.

If an insolvency practitioner is appointed to run the site and complete the development, regulatory issues may prove costly and time consuming, especially if remedial works are required. There may not be sufficient funds in the receivership/administration to carry out such remedial work, and the lender may find it has to make further advances in order to fund the works. It will be difficult at the start of a project to ascertain the extent and scope of the duties that may arise. Ultimately, there is a risk that the cost of undertaking such works may outweigh any benefit in completing the project.

In some circumstances, notably in relation to health and safety offences, an administrator or receiver appointed to complete the development could find themselves liable in a personal capacity, since many of the offences relate to the particular business carried on by the company. These offences may require remedial action to be taken, but may also carry a defence of reasonable practicability. An office holder would need to have specific detailed advice in each set of circumstances, to ascertain what a reasonable course of action would be. For example, required works may cost millions of pounds, but there may be a more cost effective and acceptable alternative. Lenders may find it difficult to find an insolvency practitioner willing to take an appointment which could involve him incurring personal liability.

If the company is in administration, the statutory administration moratorium means that a Regulator would not be able to instigate proceedings without the permission of the administrator or the court. This is not the case if the company is in receivership, where there is no statutory moratorium.

Since these liabilities attach to the land, a lender may find itself at risk of taking on those liabilities if it takes a property onto its books, and mothballs it. A lender would be well advised to conduct a full investigation of the site, including commissioning full investigations and reports, prior to taking a development property onto its books.