Should a developer ever be expected to give away its rights as employer under a building contract? You may think the short answer is no, and certainly not when the contractor is about to start work on site or in the middle of the build period. This is precisely when the developer needs to be able to pull the contractual levers and enforce the contract terms.
But surprisingly, some funders and their lawyers don’t see things that way. Instead, they insist that the developer’s rights under the building contract, any consultants’ appointments and any associated novations, collateral warranties or third party rights are absolutely assigned to the funder as a condition precedent to the release of development finance under the loan agreement. All this is, of course, in addition to the myriad of collateral warranties (or third party rights) required to be given directly to the funder.
I’ve struggled to make sense of this. In my mind it’s akin to buying a new car with a bank loan, only for the bank manager to appear at the showroom, congratulate me on my purchase and relieve me of the car keys (for “safe keeping”) along with the steering wheel for good measure. He then insists that I drive him back to his branch. You don’t need a satnav to know that his reasoning has taken a wrong turn.
Getting into a “rights” mess
What are the consequences of an absolute assignment of rights under the various project documents to a funder? As it seems to me, they include:
- Inability to enforce contract terms. As already indicated, if a developer absolutely assigns its rights to someone else, it ceases to “own” them and can no longer use or enforce them. How, then, can it administer the building contract? At the same time, the loan agreement will expressly require the developer to enforce the terms of the project documents. This only serves to magnify the contractual conundrum.
- Collateral warranties/third party rights. Similarly, how can a developer comply with its obligations under agreements with purchasers and tenants to provide collateral warranties (or third party rights) if it no longer has the right to call for them?
- Using up permitted assignments. The number of absolute assignments permitted under construction contracts is likely to be capped. The funder’s demand for an absolute assignment may inadvertently prevent the developer from assigning the contracts to another party at a later date.
Perhaps none of this much matters if everyone takes a pragmatic approach and carries on regardless. However, at the very least it raises the question of whether an absolute assignment is necessary and how this muddle has come about in the first place.
The roots of confusion
The answer, at least in part, comes down to the various types of assignment under English law (legal assignment, equitable assignment and assignment by way of security) and how easy it is to confuse them. Assignment by way of security is perhaps the most likely to give rise to confusion because, depending on how it is drafted and what notices are given, it may be either a legal or an equitable assignment. Moreover, “assignment by way of security” is not a term of art and means different things to different people.
The type of assignment with which I am concerned is typically stated to be an absolute assignment, subject to an obligation to reassign rights to the developer on repayment of the loan. If (as is common) the loan agreement requires the developer to notify its contractor and consultants of the assignment, it will take effect as a legal assignment.
The confusion that can surround such assignments is often exacerbated by the mysterious wording of the notices of assignment. These may state that, while there has been an assignment by way of security and the rights have transferred to the funder, the notified party is to continue to deal with the developer on a day-to-day basis. What does this mean in practice? It seems rather like the funder having its cake and eating it. But does it really give the funder what it needs? After all, it does not want to take on the role of developer, unless the developer defaults and it has no other option. It is surely not in a funder’s interest to put its borrower in a position where it can’t enforce the terms of the contracts it has entered into, other than by joining in the funder as a party to the action. The case of Bexhill (UK) Ltd v Razzaq is a good illustration of this.
Is there a way of protecting the bank’s interest under the project documents that avoids these issues? Two possibilities come to mind:
- Assignment by way of charge. A charge gives the bank a right to use the charged assets to pay off the borrower’s debt. It does not transfer ownership to the funder or give it a legal right of possession, but creates an encumbrance or interest that attaches to the asset and can be enforced (under the terms of the loan agreement) if the developer defaults.
- Deferred assignment. Under this option (which may be combined with a charge) the assignment doesn’t take effect until the developer has defaulted under the loan agreement. At that point, the assignment is perfected by giving notice to the contractor and consultants. By then, of course, the developer is likely to be practically unable to enforce its rights under the project documents. In short, the developer’s rights will pass to the funder only when it needs them and the developer does not.
As I’ve said, assignments to funders are a perennial source of confusion. Adopting one (or indeed both) of these options should enable all parties to cut through the mystique and allow developers to manage their projects, while giving funders the security they crave. My bank manager can have his charge, but I get to keep the keys and the steering wheel – at least for now.
This article was first published by Practical Law Construction as part of our regular construction blog series in which we share our practical experiences of working in construction and engineering and give our opinion on the current and future legal developments that shape and will shape the industry. To read more from the series, visit the Practical Law blog.