The general concept of ‘real estate finance’ can cover loans to assist a borrower with the acquisition of a property (whether residential or commercial) or refinancing an existing loan secured against the borrower’s property, loans for the borrower’s business purposes that are secured against property that it owns and loans for the development or construction of property.
Borrowing against an existing property (that has already been built) will, in broad terms, follow standard(ish) legal steps with which many homeowners are familiar, to provide security to a lender. Generally, there will be some form of loan agreement that imposes on the borrower certain financial obligations (i.e. obligations to pay interest and repay the loan sum that was lent) and property obligations (to take steps to maintain the value of the property throughout the duration of the loan agreement, e.g. by requiring the borrower to keep the property in repair, to insure the property, not to cause or permit damage to be caused to the property etc.) and the borrower will be required to enter into documents to provide security in favour of the lender (usually a first legal charge/mortgage over the property and sometimes guarantees in favour of the lender). Development Finance can differ from these more familiar real estate finance methods and additional legal steps and documents may be required.
‘Development finance’ or ‘construction finance’ involves a lender providing a loan to a borrower for it to develop (i.e. build, extend, renovate or refurbish) a property. It can form part of a loan that is made to also acquire the property that will be developed. The loan is secured against the property (as with other forms of real estate finance) but security will also be given over the developer’s (i.e. the borrower’s) rights under relevant construction documents – e.g. security over rights of the borrower/landowner under the contract with its building contractor to carry out the development and overs its rights under services agreements with other professionals such as the architects and engineers for the construction project – as well as security over the borrower’s rights to proceeds of insurance policies relating to the property and the construction project itself.
A prudent lender will usually insist on a full due diligence review not only of the property which is being provided as security, but also a full review of the planned development and all construction contracts and the contractors themselves before funding is released to the borrower. The lender will want to review:
Lenders of ‘standard’ real estate loans (that do not involve construction elements) normally impose numerous conditions precedent (known as ‘CP’s) such as requiring satisfactory reviews of the property title documents, insurance, appropriate consents and authorisations and planning permissions etc. These CPs must be satisfied by the borrower before the lender will make any funds available to the borrower.
The list of CPs for a construction loan/development loan will include all of these ‘usual’ conditions and impose numerous further construction specific conditions, such as requiring sight of signed building contracts, professional appointments, professional indemnity insurance documents and collateral warranties, as well as detailed budgets that have been approved by the lender’s representatives.
It may be that the construction loan will be released in separate tranches when certain phases of the development have been reached, and in that case it may be that there will be CPs that need to be satisfied at each stage of the development process, possibly to be signed off at each stage by the lender’s own monitoring surveyor (who would represent the lender, but whose fees must be paid by the borrower).
It is for these reasons that the various documents required for a development loan will be more detailed and complicated and accordingly they take more time to negotiate and finalise between the parties and their lawyers than would be the case for a loan that does not involve construction elements.
Development finance or construction finance facilities are complex, and the legal processes can take a long time, involving many legal advisors acting for the borrower, the lender and sometimes for the building contractors as well. At Quastels, we have experienced lawyers in our Finance & Banking, Real Estate and Construction departments who work together as a single team to progress matters for our clients (both borrowers and lenders) as swiftly as possible.
To discuss any of the points raised in this article, please contact Jason Greenberg or fill in the form below.
If you are considering lending money to a family member or a friend, you may believe you are acting prudently by obtaining security (for example, a mortgage) against the borrower’s home to ensure you get your money (and any agreed interest) back.
However, without getting professional legal advice, you could find yourself inadvertently straying into the realms of a regulated mortgage contract (RMC). If this occurs, the loan contract may be deemed unenforceable, and you could be in breach of the Financial Services and Markets Act 2000 (FSMA).
Under article 61(3)(a) of the FSMA (Regulated Activities) Order 2001 (RAO), a contract is a regulated mortgage contract if, at the time it is entered into, the following applied:
Under the RAO, anyone who is not authorised to carry out a regulated activity is prohibited from doing so. The contract will be unenforceable and criminal charges may be laid.
An example of how someone can suddenly find themselves entering into an RMC without meaning to is illustrated in the case of Jackson v Ayles and another [2021] EWHC 995 (Ch).
Mr Pumphrey lent money to Mr and Mrs Ayles, the Defendants. The Borrowers were property developers. The loan was secured by a charge on their family home. The Ayles defaulted on their loan repayments and declared bankruptcy.
Mrs Jackson, the Claimant, was subsequently appointed Mr Ayles’ trustee-in-bankruptcy. She applied for a declaration that the security held by Mr Pumphrey was unenforceable under FSMA.
Mr Pumphrey contended that because the activity had not been carried on “by way of business”, it was not regulated and so did not infringe the general prohibition in section 19 of the FSMA. The High Court disagreed because:
The Court ruled that Mr Pumphrey was not an authorised or exempt person for the purpose of the FSMA. He was therefore barred from carrying on a regulated activity but did so anyway. He was therefore in breach of the general prohibition in section 19 of the FSMA. Consequently, the loan was unenforceable under section 26(1).
Article 61A(1) and (2) of the RAC provide that a contract is not a RMC if it falls into one of the below categories:
If one of the above exemptions applies, the loan agreement is defined as an unregulated mortgage contract.
Given that inadvertently creating an RMC can lead to expensive civil litigation and criminal prosecution and could potentially leave you with an unenforceable loan agreement, it is important to seek legal advice if you are considering providing a loan that will be secured over property.
Doing so will ensure you understand the consequences of the contract and that you are able to protect your best interests.
To discuss any of the points raised in this article, please contact Jason Greenberg or fill in the form below.
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