Bespoke and be damned

For contractors, life has been good. For developers, faced with rising costs and limited construction resources, a cautious insurance market and the credit crunch, the market is challenging. One of those challenges is that developers are under huge pressure to involve contractors early in their schemes. A resulting increase in negotiated rather than competitively tendered contracts is being seen.

Contractors, understandably, have been seeking to take advantage to better secure payment. For debt-funded schemes, using a special purpose vehicle (SPV), requests for direct payment by the bank is not uncommon.

Where a developer gets into difficulty, banks may consider whether they exercise their collateral warranty “step-in” rights to continue. Where they do so, commonly this will be subject to payment of outstanding money.

A contractor, of course, has statutory rights to suspend its obligations under the provisions of the Construction Act where the developer fails to pay, as well as a right to sue for contractual breach.

However, recent market conditions have seen contractors seeking extended payment protection such as the clause below. But contractors and developers should be aware that these attempts that go beyond more common arrangements are likely to come unstuck.

A bank providing development finance faced with a contractor seeking such a clause is unlikely to approve the form of building contract as satisfactory construction security and to allow draw of funds. Why?

Well, the clause does the following things:

• In effect, it treats the bank as a party to the building contract
• It does not recognise that funding arrangements commonly need to be varied to respond to a developer’s change in circumstances and changes in the scheme being undertaken
• It potentially exposes the developer to claims for misrepresentation and breach of contract. Where funding arrangements are changed, under the clause such change may be considered a fundamental breach and the contractor may argue he is permitted to rescind the building contract – a serious construction security risk to the bank
• It undermines the position of the bank where circumstances arise where the bank otherwise may traditionally “step-in” to replace the developer under the building contract.

In “stepping-in” the bank will be bound by the provisions of the clause and (as the new employer) would have to divulge and adhere to funding arrangements previously agreed with its former customer, the developer, notwithstanding that the developer is in default.

Usually in such circumstances, bespoke funding arrangements would fall away. Effectively, this confirms a line of credit from bank to contractor in the event of a developer’s insolvency without any of the usual steps that a bank would take to establish customer credit worthiness and to protect its position, and arguably it forces the bank to fund directly the build-out of the scheme.

Although in the current market, steps to protect a contractor’s right to be paid are understandable, protection in a similar form to this clause is likely to mean “no deal”!