Developers should review their contracts to determine whether they are sufficiently flexible to protect themselves against, and take advantage of, the current uncertain market conditions. A well drafted contract can do both.
Having regard to key development contracts, this article examines some of the main provisions which developers should review in order to determine contractual flexibility.
Right of Variation
A developer should review its contracts to determine whether it has the ability to vary the scope, nature and/or timing of a project. This could enable it to take account of the current market conditions, such as falling end user demand for luxury residential accommodation or to simply reduce its costs.
In Bahrain, development agreements often require the developer to produce preliminary, schematic and detailed designs within a certain period and to submit these for approval by the counterparty (e.g. a master developer, a fund/investor or a corporate occupier). Typically, once these designs have been approved there is little or no right to vary.
Alternatively, a development agreement may entitle a developer to make certain ‘permitted’ variations. A ‘permitted’ variation will be defined in the agreement but is likely to relate to variations or changes which are insubstantial or immaterial in nature or which do not affect the size, layout or appearance of the works. Variations of a material nature would usually require the consent of the counterparty.
A developer is also likely to have a right to vary the works under its building contract but a contractor may have the right to raise objections. A developer will need to consider the effect of any proposed changes. Subject to the governing law of the building contract, variations which are so fundamental that they go to the root of the contract or fundamentally change the nature of the contract may not permissible irrespective of the breadth of the variation provisions contained in the building contract. Such changes are likely to affect the validity of the building contract and result in the contractor being able to make a claim against the developer for breach of contract.
A developer should also determine whether it has the ability to omit works and give these to another contractor in order to capitalise on greater competition or lower construction costs. Often such a right is specifically excluded from the building contract.
A developer should also review any sale agreements it has entered into with end purchasers. Such agreements are likely to require a developer to construct a unit to a certain size in accordance with plans and specifications that are attached to the agreement (and be subject to a price adjustment mechanism if the size of the unit differs from that agreed). Save for the above requirement, a developer is usually entitled to make such variations to the unit as it deems necessary.
A sale agreement is unlikely to impose detailed development obligations on a developer in relation to the remainder of the project such as the nature and extent of the facilities to be provided within the development. However, the lack of any contractual restrictions does not necessarily mean that a developer has free reign to undertake variations as a Bahraini court may seek to protect and compensate consumers if expected amenities are lost.
Right of Suspension
A developer may wish to suspend or delay its project. This is a useful mechanism to ensure that a development is not completed in a depressed market.
A development agreement is unlikely to contain a right for a developer to suspend the project. It will usually require that the works are completed by an agreed ‘target date’. This is commonly a period of sufficient length to enable the developer (through its contractor) to undertake and achieve practical completion of the works.
A developer will be able to assess whether the target date is sufficiently flexible to allow for any suspension of the works and/or whether it can phase completion of the works.
The target date can normally be extended for a number of reasons (e.g. force majeure or to take into account any extensions of time permitted under a building contract). A developer may have the right to suspend works under its building contract entitling the contractor to an extension of time. If the extension provisions in the development agreement are sufficiently wide, this could trigger an extension of the target date and therefore achieve a developer’s aim of delaying the project.
Although a developer is likely to have a right to suspend the works under a building contract it will need to consider its financial liability if it exercises this right. Liability could arise to the contractor for the cost of protecting, shoring-up and keeping safe any incomplete works. Such rights are often limited. In the event of prolonged suspension, a contractor will often have the right to request an instruction to proceed and, in the absence of such instruction, terminate the building contract for developer default.
Right to Terminate
In some circumstances, a developer will look to terminate its contracts so as to extricate itself from a particular project. However, a developer can also use termination provisions where it is intending to continue with the project but on different terms so as to take advantage of falling land, labour and material prices.
A developer should check whether the development agreement is subject to any unsatisfied conditions precedent entitling it to terminate. These will need to be examined carefully as a developer will generally be under certain obligations to satisfy any conditions precedent and may be exposed to a claim for breach of contract if it fails to comply with such obligations. The development agreement should also be examined to assess whether any rights of termination exist but have not been enforced (e.g. if the design has not been agreed in accordance with the timeframe set under the development agreement then a termination event may have arisen). In all circumstances, the position will need to be carefully considered to ensure that the developer has not waived any such rights.
Although such a right is relatively unusual in a development agreement, a developer should check whether its development agreement can be terminated at will or “for convenience”.
The exercise of any rights of termination should be balanced against the potential loss of the deposit (or a greater sum depending on the terms of the development agreement). The impact on goodwill and market perception are also factors to be considered.
Provisions to terminate at will are often contained in building contracts. If a developer does not have an express contractual right to terminate at will, then a developer should seek advice as to the grounds upon which it is entitled to issue a termination notice, such as for contractor default.
Even if a developer can terminate a building contract at will, it will need to consider any rights a contractor may have to claim compensation over and above the value of the works undertaken, such as sub-contractor breakage costs, demobilisation expenses and lost profit.
A developer wishing to terminate a sales agreement will need to consider its liability carefully as such action could prejudice any claim it may have against existing defaulting purchasers and could give rise to claims from other purchasers.
The above are just a few of the clauses which developers should review in order to determine the flexibility of some of their key contracts. The importance of having a well drafted contract which can adapt to current market conditions is of critical importance. It may even determine whether an existing project can continue or not.