The Newpoint Advisory Partners have managed over 50 distressed property assets valued at over $1B across all asset classes and locations in Australia. In this article we look at the longstanding practise of development lenders accepting Statutory Declarations as evidence that project creditors are being paid.
Contract Builder or Owner-Builder?
Development lenders need to make an informed decision about a builder’s ability to complete a project. Two options are considered by development lenders: Contract Builder or Owner-Builder:
When approving the builder, appropriate risk mitigants (e.g. tri-partite deed, retention arrangements) are put in place.
Development lenders favour Contract Builders. They like developers to lay-off their construction risk, just as they do their market risk via presales. Owner-Builders can also lay-off construction risk to their subcontractors and suppliers, but additional equity may be required by development lenders.
It is the longstanding practise of development lenders in both scenarios to insist on two key items before paying a progress claim directly to the builder:
- Obtain Quantity Surveyor certification of the value of the work complete on a trade basis: This is to ensure that the project is not “overclaimed” and to mitigate any future risk of the development lender “double paying” in a distressed project situation.
- Statutory Declaration from the builder attesting that all wages, subcontractors and suppliers on the project are paid-up within terms. This is to “ensure” that subcontractors and other creditors are being paid for the work completed and also to mitigate any future risk of the development lender “double paying” in a distressed project situation.
Are Builder’s Statutory Declarations weak risk mitigants?
A Statutory Declaration is sworn under the Oaths Act 1900 and making a false declaration is a criminal offence.
Statutory Declarations do not provide a physical constraint on the flow of funds to subcontractors and other creditors. Ordinarily, progress payments are made to builders, not to the individual subcontractors and suppliers. There is no direct linkage between the value of work completed on a project (on a trade basis) and the payments a builder makes.
The lack of transparency with Contract Builders is an accepted risk. Greater transparency is required by development lenders when dealing with Owner-Builders. However, in both scenarios, the current industry requirements are not successful in mitigating this risk.
Where did all that money go?
In distressed situations, our experience has revealed that there are invariably unpaid project subcontractors and suppliers, and sometimes there are unpaid taxes and employees. Disputes can arise as to whether funds owing are “due and payable”, but we can often infer that previous Statutory Declarations were inaccurate. Discovery is “cold comfort”.
We have seen that funds can be misapplied towards the following:
- Pre-existing creditors
- Warranty claims on prior work
- Undisclosed cost overruns
- Losses on other projects
- Costs of new projects
Risk mitigants that development lenders might wish to consider
Should development lenders continue to rely on Statutory Declarations? What other alternatives could be considered?
Under both scenarios
- Obtain an independent builder financial review before approving the builder (please refer to https://www.newpointadvisory.com/builder-financial-reviews/). Prevention is always better than the cure.
- Minimum: Require Statutory Declarations to attach supporting schedules of creditors and suppliers paid by the builder during the month.
- In high risk scenarios: Require Statutory Declarations to attach supporting accounting records verifying the schedule of creditors and suppliers and the amounts paid by the builder during the month (source documents).
We recommend that development lenders read our Lender Advisory: builder financial covenants and builder’s tie-in deeds.
Building contracts regularly require developers to provide evidence of adequate construction funding. However, there is no reciprocal requirement for ongoing financial disclosure by builders. This is not acceptable to development lenders in distressed project situations.
The tri-partite deed provides an opportunity for the development lender to insist on the establishment of an acceptable financial information framework, such as:
- If a material loan default arises
- Development lender will consider exiting the development or exercising its step-in rights
- The contract builder must satisfy the development lender’s reasonable enquiries about the financial status of the project and the builder’s overall financial situation.
- Completion strategy adopted by development lender. Generally, a receiver is appointed by the lender
- Minimum: Require regular financial updates (e.g. at monthly PCGs) and full ongoing disclosure of subcontractor and supplier arrangements.
- In high risk scenarios: Make direct payments to subcontractors and suppliers.