This is where in the property development project you inherited you wipe the slate clean of current contracts and relationships to restart free from historical baggage and constraints. The premise being there is no value continuing with existing contracts.
This is progressively more difficult to do (or at least carries more risks), the further developed the project already is. Let’s look at cleaning the slate at various stages:
- Conceptual design. At this stage there isn’t much to lose if you want to ditch the existing architect and consultants and start fresh. If this project has been one with a poor payment performance record, the existing team may be low on motivation. Their emotions may not change with new owners (you). You will lose some intellectual property and knowledge by abandoning them. But it shouldn’t be too much of a problem for new consultants to get up to speed. Just check whomever you replace is not the only expert in their field for your type of project or has political connections where you may find yourself embarrassingly having to go back to them in the future. At this stage you won’t have buyers or contractors involved, so no problems there.
- Developed design and planning consent. Before cleaning slate, get copies of all delivered reports, plans and specifications from consultants and where possible the raw electronic file formats used (CAD/BIM for example) so your new team does not have to recreate all the work previously done. Town planning involves relationships with authorities so think carefully before changing. Ensure you have all correspondence from local planning authorities, especially where the town planning consultant had authorisation on the previous developer’s behalf.
- Building consent. Not only do you want all files, preferably in their raw format, but also copies of all design statements, producer statements and certifications. Check that the consent documentation submitted does not implicitly require that same consultant to undertake inspections or sign-offs later in the project. If it does, ensure your new consultants can do those signoffs or make provisions for the existing consultant on a limited scope. This is very important if building consent has been granted and extremely important if the element has already been built. I have been in the situation where an engineer in a legal dispute did everything possible (contrary to professional ethics) to frustrate us by refusing to hand over a certificate for an item of infrastructure already built and inspected (with no problems). No other consultant wanted to sign off this item. It ended up a very costly exercise to ‘extract’ the certification. Intellectual property and liability collide at this point though. Ensure any new consultant will take on the responsibility of previous drawn plans.
- Under construction. Ensure there are no certification or liability issues with the consultants you are terminating, before you terminate. For contractors, the issues are further compounded, especially with responsibility over warranties and guarantees. If you are considering terminating a contractor then you need to plan to get all warranties, guarantees, certifications and as-built documentation for work in place. Many of these will come from subcontractors and suppliers and you may have to negotiate with each separately. If the subcontractor has experienced payment problems, then it may be difficult to get these certificates. Although you are terminating a main contractor, there could be key subcontractors who you need to retain just because it is easier to keep them on to avoid problems gaining final approvals from the local authority. If subcontractor continuity[1] agreements exist it will be much easier to deal direct. For work that is partially complete, or where your audit finds it may have not been done correctly, be especially careful. Subcontractors may have an incentive not to help if they have played a part in the project’s failure in the first place. They may have cut corners as a project deteriorated (lack of payment or lack of competent inspections) and will no longer want to take any responsibility. Others may just be holding out for a payment. If the existing subcontractors do not want to assist you, or you are forced to terminate them because of their incompetence, then you will need to specifically address how you are going to complete the works and get the appropriate certifications. You may need to discuss the circumstances with the local authority, so they will accept a new contractor’s certification. This could include retrospective inspections, or unfortunately, rework. Sort all this out before you restart construction in earnest. Review every official certification or signoff you need in relation to what has been built and tick off exactly what you need and have a plan to deal with what may create difficulties. If you don’t do this at the start, and only find out from the local authority that you need a certificate for this item many months later, the amount of rework could increase significantly. As an example, think of the situation where you don’t have certification for waterproofing at the base of building but now you have built an entire building on top of it. Catch-all guarantees, such as weather-tightness or multi-year warranties provided by the main contractor, will be difficult to retain if you are terminating them. Ensure you can get your new contractor to provide this or at least provide a limited one that excludes work already done. Obtaining an insurance policy to cover the same risk may be an option. Don’t forget to cross reference what has been promised to purchasers and lessees in their contracts as well.
- Sales or Leasing. Assuming you have the control and right to cancel,the formula is straightforward. If the value of contracts in place is greater than the current market value, then retain them. If they are less, then you renegotiate or terminate. Although it may be more difficult than that. Some buyers or lessees could have been given so many broken promises that their existing relationship with the project is fractious (and litigious). The pain to continue with them may just be too much. Illustrating some of the complexities that need to be thought through:
Say you have taken over a commercial project, 50% complete, where one of the tenants signed up is a medical laboratory. Substantial work has been undertaken to customize the base building for this tenant. There are no potential replacement tenants, and a lot of work (money and time) would be required to reconfigure the space to attract alternative tenants. Canceling this tenant may simply be too costly. This tenant likely has strong negotiating power in this situation, even if they have signed up at below market rates. Your position will be stronger if this tenant has no alternative options or are under pressure to occupy the premises.
Suppose you have existing agreements to lease on a retail shopping center development. All the minor tenants are signed up at above current market value rates. However, the large anchor department store tenant has been signed at a rate so ridiculously low with such large incentives they are the main reason this project has failed. You want to terminate the anchor but keep the minor tenants. The only problem is the minor tenants have clauses linking them to the anchor’s presence, and in the current floundering market you definitely don’t want to terminate all those minor tenants.
Or
consider the scenario where you have taken over a 50-unit terrace home
development that is completely presold. Construction costs
have ballooned out and there is not enough revenue to cover the required
development budget to complete the project. Given your high opportunity
acquisition price, canceling sales contracts is necessary; however, some
contracts are below market value, some are at market and some are above market.
Do you just cancel some or do you cancel all contracts? The residential market
is also slowing down so resales at the price required will take some time. The
project is high profile and canceling agreements is likely to generate
consequential negative publicity that could put off resale buyers. Plenty to
think through!
[1] A subcontractor continuity agreement is typically put in place between developer, funder and main contractor within a tripartite agreement. It allows the developer or financier to step in and manage subcontractors directly if there is a default by the main contractor.
Andrew Crosby
+64 21 982 444
andrew@xpectproperty.com
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