The practices of funders' lawyers in 2011

Hard times for the construction industry and the funders seem to be in charge. They are presumably under pressure to deliver blue-chip assets only following the sub-prime debacle. And it appears that their instructions to their advisers are to ensure that their security is rock-solid. So their construction lawyers, who rarely also act for other parts of the industry, seek to impose onerous terms on contractors, not seen in more buoyant markets, which the lawyers then seek to argue are “market standard”. So it would be completely unreasonable, they imply, for the contractor to resist.

Suggestions from the contractors’ advisers that these are not “market standard” are then airily and patronisingly dismissed. And what have been 2011’s favourite examples of “market standard” practices?

• More of the usual in relation to the plethora of collateral warranty requirements. It is now “market standard” for collateral warranties to be given to forward purchasers (in addition to funders and first purchasers) and mortgagees (not just funders providing construction finance) as well as freeholders, long leaseholders, etc - even when they have no profit-share at risk from the contractor’s default.
• Third party rights are not “market standard” for those beneficiaries who need step-in rights (despite the best legal advice suggesting that they are perfectly sufficient) so the needless effort and costs of securing collateral warranties are imposed on the industry at a time when more than ever it is vital that it eliminates waste.
• It is (inevitably) not “market standard” to include as terms of the collateral warranties/third party rights a net contribution clause, but it is “market standard” to insist on provisions which state that the consultant/contractor cannot raise “no loss” arguments in defence of liabilities under a collateral warranty/third party rights.
• And of course these days there must be some draconian sanction for failure to deliver collateral warranties as required. A claim for breach of contract is not enough and instead it is “market standard” for contracts to include “penalties” which may be withheld from payments due to contractors if they or their subcontractors fail to deliver collateral warranties. Interesting to see what effect those penalties have when collateral warranties are sought some time after practical completion of the project which is always when most difficulties arise in securing them. And how does it help anyone if the subcontractor becomes insolvent or walks off because it is not being paid? And why do funders need “step-in” rights from subcontractors anyway? Are they really contemplating kicking off the developer and the contractor and taking over the subcontractors themselves?
• It is of course “market standard” to require contractors to accept that obligations contained in Third Party Agreements with freeholders, adjoining owners, and so on, are stepped down to them. Perhaps this is not unreasonable in the context of agreements that can be disclosed to the contractor during the tender period or as part of the contract negotiations. But it is now argued that it is “standard practice” to require the contractor to accept that any future agreements which may be entered into by the employer can be unilaterally imposed on the contractor and it should indemnify the employer against breach of them. Crystal-ball glazing has become part of a contractor’s skill set. For some employers/funders this extends as far as changes in the statutory requirements during the course of the project - of course the contractor’s price can include for that.
• Other clever ideas include carving out the contractor’s entitlement to extensions of time following the occurrence of a specified peril where the contractor’s negligence or default has caused the fire, etc. So the project goes up in smoke the day before practical completion and the contractor pays liquidated damages for the full period of reinstatement? How sensible is that?

And so it goes on … Maybe all of this is not actually coming from the funders/banks but just from their lawyers? Perhaps tighter management of the legal budgets might help?

It is trite that risk should be allocated to the person best able to manage the risk concerned. Why does that old adage seem to carry no weight when the commercial advantage moves? Surely no one can complain when the wheel turns and the contracting industry responds in kind?

Ann Minogue is a construction partner in solicitor Ashurst