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Development Lending – Developing Problems
A recent High Court case highlights the issues which can arise in development lending and the circumstances in which a lender will fail to recover losses from its monitoring surveyor. Governors and Company of Bank of Ireland & Others v Watts Group (2017) is one of the first cases which looks at the responsibilities of monitoring surveyors in development lending and provides important guidance as to good practice on when to lend, and how to manage drawdowns in a successful development loan.
The Facts
Bank of Ireland approved a £1.4m facility for a development of 11 apartments in York in 2007. Its customer was a SPV owned jointly by a key client and a development contractor. The Bank had a £20m exposure to its key client, and likely would try to accommodate the client’s needs where it could, for its own commercial reasons; key consideration, according to the judgment, in the lender’s decision to lend. The loan was made up of £210,000 for the land purchase, the balance for development costs. The lender relied upon a Savill’s report (who had already been commissioned by the borrower to report) for the loan approval, and a monitoring surveyors report for the loan drawdowns. In addition to its charge, the Bank took a capital guarantee from its key client, and both the long-established client and the contractor entered into a costs overrun agreement and interest shortfall guarantee. The contractor entered into a fixed price contract for the construction works. The cost of the development was c £1.8m. The GDV was c £2m, leaving a profit of a mere £200,000 on the development, if all was successful and everything ran to plan (no pun intended). Notably, the lending exceeded the Bank’s own underwriting parameters on loan to cost, loan to GDV, and site value to development cost ratio.
So, it would appear, the Bank covered all bases, security-wise at least.
Post loan completion, the Bank instructed an independent monitoring surveyor to report on
• The developer’s costs construction estimate
• The developer’s build programme time estimate
• Developers cashflow
The report was intended to provide the Bank with comfort as to the feasibility of the project before further drawdowns were sanctioned, the land acquisition having already taken place.
An acceptable report was received, and the Bank proceeded to advance drawdowns.
When things go Wrong
By 2009, the key client was no longer so key, having entered into administration. This resulted in the developer becoming insolvent, and the construction ceased. The security was realised and the bank suffered losses of c £750,000.
The Bank looked to recover its losses. The Bank claimed its losses from the monitoring surveyor, who, it said, had underestimated construction costs, the time required for construction, and who failed to identify discrepancy between drawings of the proposed scheme and planning permissions granted. Had they competently reported, so said the Bank, drawdowns would not have been made.
The Bank based its claim on the original report, but made no claims in relation to the subsequent monitoring inspections and reports.
And the Court Found
On the expert evidence, the court concluded that the monitoring surveyor had not been negligent in
• approving the costs estimate, which had been based on the developers own estimate which was not unreasonable.
• approving the cashflow
• confirming that the developers time estimate was reasonable
• failing to identify discrepancies between drawings and planning. The monitoring surveyor had not been provided with accurate and up-to-date drawings by the lender, and had notified the Bank that insufficient documents had been provided
The monitoring surveyor received a fee of £1,500 which suggested that it had not been expected to perform a detailed forensic analysis at that price.
The Court did confirm that the Bank could place reliance on the report, and determined that the loss that could have been recovered if negligence had been proven would have been reduced by 75% by reason of the Bank’s own contributory negligence.
Lessons to Learn
Although at first glance, this case is not helpful to the lending community. However, it is important. The specialist finance community has only fairly recently entered the development space, and I am now seeing problems and issues surfacing in this particular area. So, this case is important because it serves to highlight a problem area, and a new litigation trend. It also offers guidance on good practice and how to behave, and not to behave, when transacting in this area. There are a number of key lessons to be learned from this piece of 2007 lending, albeit, by an institutional source.
• No matter the relationship with the client, no matter the exposure, every lending piece should be unwritten on its own facts and circumstances.
• Each lending piece must and should meet underwriting criteria. A monitoring surveyor does not underwrite the risk where criteria are ignored.
• Carefully consider the client experience. In this case the key client had never transacted a joint development of this character and nature.
• You get what you pay for. If a detailed forensic analysis is necessary and is what is required, then a commensurate fee is appropriate and operates to indicate the significance of the report.
• When instructing a monitoring surveyor, always provide detailed instructions which should outline exactly what is required. Instructions should include a full suite of documentation including development plans and up-to-date planning permissions and drawings.
• And following first report, regular reports should be commissioned on the same basis and understanding. A lender will often have a more intimate knowledge and engagement with the development, so consider attending inspection to avoid confusion and misunderstanding.