S.106 development agreements: termination provisions
How can registered providers strengthen their position?
Termination describes a contract expiring or being brought to an early end, either under common law or under a termination clause in an agreement. This article focuses on contractual termination and explores the tensions around early termination provisions in s.106 development agreements.
What is a s.106 development agreement?
Some s.106 Agreements contain obligations to deliver, and to ensure occupation of, affordable housing. This places the burden on housebuilders to secure commitment from RPs to ensure such affordable housing obligations can be met. At the same time RPs are keen to take on new affordable housing as a new asset and to fulfil their objectives. This situation has driven the creation of a type of legal agreement often referred to as a ‘s.106 development agreement’ made between the housebuilders and RPs to record the terms of that arrangement.
Why do early termination tensions exist?
In s.106 development agreements made between RPs and housebuilders, it is usual to find contractual termination rights linked to an insolvency event. This is because if either party becomes insolvent, the other party may want to exit the development agreement and look for a new development partner. It is very unusual for an RP to suffer insolvency; historically, the regulator or another RP is likely to step in to rescue a failing RP from such a situation. In comparison, housebuilders are far more exposed to insolvency risk and in an economic downturn this risk is enhanced.
However, in negotiating a s.106 development agreement you may find the housebuilder strongly resists more extensive early termination rights in favour of the RP. The housebuilder wants the maximum control over its ability to comply with all the obligations in the s.106 agreement to ensure the wider scheme can be delivered to its timescales. Therefore express termination rights for the RP, beyond housebuilder insolvency, are often unpopular. On the other hand, an RP may want an express right to terminate if the housebuilder’s performance is unsatisfactory. Perhaps the building works are behind schedule, there are issues with quality of finish, or something is built that does not correspond with the specification.
What can you do?
It is good practice to ensure that a right to terminate on housebuilder insolvency is a standard requirement but in respect of other termination rights in favour of an RP, is there a way of managing the gap between the RP and the housebuilder on early termination?
There may be contractual and commercial considerations that bring comfort to RPs where express termination rights cannot be achieved in the s.106 development agreement. If the affordable and private units are integrated (for example, within a block of flats) it is more likely that the housebuilder is incentivised to complete the whole development. This is because they will want to get their own units on to the market as soon as possible to achieve their sales targets and are more likely to do so by marketing a fully finished and completed asset. In addition, the parties could agree significant payments in the s.106 development agreement, linked to milestones agreed upon by the RP; if the milestones are not met then the payments are not made. It is possible for a s.106 development agreement to contain ‘step in’ rights for the RP, to terminate and take on the scheme. However this scenario is more feasible if the situation lends itself to the RP being able to complete the development of the affordable housing in isolation from the rest of the scheme.
Other ways to strengthen an RP’s position are:
- Where you have a right to terminate on the housebuilder’s insolvency make sure the insolvency event provisions are reviewed by your legal team and updated to match the most up to date legal position. It is not unusual for insolvency definitions to be out of date (as housebuilders tend to recycle documents). You need to be sure that an early indicator of insolvency is captured.
- Make sure the dispute resolution clause in the s.106 development agreement provides for dispute escalation and discussion between executives, and behind the scenes make sure there are amicable lines of communication between the parties at all levels.
- It is rare for a housebuilder’s performance to deteriorate dramatically overnight. There is often a track record of small failures and deviations before they add up to something more troublesome. Make sure your development or contracts manager has oversight of the housebuilder’s progress and the position on the ground, as well as access to the right legal resources, so you can take action to protect your position at the earliest sign of trouble.
- Make sure you have done your due diligence on the housebuilder’s financial position at the outset and if its covenant strength is weak (for example the company you are contracting with is a new company with no trading history) consider asking for additional security such as parent company guarantees, bank guarantees, charges or price retentions. Refresh financial checks as you see fit throughout the program.
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