Joint ventures in property development

When entering a joint venture parties must take care to ensure that lenders are satisfied with their legal arrangements

Author:

Matthew Grogan

11 October 2019

Commercial property

Legal

Residential

A joint venture is a business or project in which two or more companies or individuals have invested time, resources, expertise or funds, with the intention of working together. Sounds simple – but when that joint venture requires finance, it is imperative that the parties are organised and obtain expert legal advice.

One of the fundamental issues for a lender in providing a loan facility to a joint venture is the structure of that venture, as this will determine the terms of the loan and the extent of the security required. In property transactions there are two common types of joint venture, both of which have advantages and disadvantages from a funding perspective.

Limited company or limited liability partnership (LLP) joint venture: this structure will most likely be a special purpose vehicle, which lenders prefer because the venture will be a clean entity, with no existing debt or security, making funding easier. However, the limited nature of the vehicle's liability means that a lender will most likely request some form of personal guarantee to support the loan.
Contractual joint venture: in this arrangement, each party will control its own assets, making it easier to identify their respective obligations. However, while this structure creates flexibility it can preclude the granting of certain security types such as floating charge, which covers assets such as bank accounts and debtors, and this may affect available finance.

Once the type of joint venture has been determined, the parties will need to agree the key terms of the deed that regulates it; these will be set out in a shareholders’ agreement, partnership agreement or a separate joint venture agreement depending on the type of arrangement. The terms of a joint venture agreement are pertinent in a lending situation, as the parties will need to avoid conflicting with the lender’s requirements. While each transaction will need to be considered on a case-by-case basis, there are two fundamental issues that must be considered in the joint venture agreement.

Control: who has control over the joint venture’s decision-making? The answer to this question will depend on the nature of the project. As an example, in a development project a lender will require the developer to have overall control of decisions affecting the development, such as build costs, appointment of professionals and completion of the scheme.
Payments and distributions: does the agreement allow payments to be made to the joint venture's parties during the term of the loan, and when are those payments due? While a lender may agree to certain payments such as a salary allowance, it will be very unlikely to agree to the payment of any capital or interest while the loan is outstanding. This may be of concern to investors in the joint venture.

The loan facility will set out the terms on which the funding will be provided. Such a facility can be a complex document, and the joint venture must consider all aspects carefully; while many of the terms will not depend on the fact that the loan is being made to a joint venture, there are certain terms that may be fundamental to a lender where one is involved.

Representation, warranties and undertakings: in property funding, the obligations on the joint venture can be extensive and will cover everything including financial warranties, reporting, corporate governance and property. The venture should consider which party is to comply with the various representations, undertakings and warranties.
Conditions precedent: a facility will require satisfaction of a number of matters before funds are made available for drawdown – these are known as conditions precedent. The parties in the joint venture must be organised and agree which of them is responsible for the satisfaction of the conditions precedent, to avoid any delay in the drawdown of funds. A facility's conditions will be broken down into sections that cover such matters as financial information and information about the property.

Security package

In a property transaction, a lender will seek to obtain a full security package including a legal charge over the target site, a debenture over the assets of the venture, guarantees (see below), and in some cases a charge over its shares or the equitable interest of the LLP. In our experience, most lenders will not entertain changes to their standard security documents; however, it is imperative that the parties in a joint venture ensure that the security package works for everyone. As an example, a landowner that is not the borrower for the purposes of the facility will need to provide a legal charge over the site; but that legal charge should, if possible, include a limited recourse clause so that the landowner is only liable for the facility up to the value of the site.

A lender will more often than not seek one or more guarantees to support a facility, particularly when that facility is being used to fund a development project. This could take the form of a capital guarantee – that is, a guarantee to pay sums that are due from the joint venture – or may be required to cover interest shortfalls or cost overruns, the latter in particular being used if the project is a development.

It is essential that the parties in a joint venture agree how to deal with guarantees at an early stage, and may want to consider the following.

Provider: which party or individual will be required to provide a guarantee? This should be discussed as early as possible to avoid delays in obtaining funding. As an example, a party that is only investing in a joint venture is highly unlikely to agree to provide a guarantee – particularly if it is a corporate investor that provides equity as its main business.
Limitation: will the guarantee be limited? A guarantee may be limited to an upper amount, but in certain cases can cover the full facility. The parties in a joint venture that are providing the guarantee should ideally seek to agree a cap on their liability and may even want to seek an indemnity in the joint venture agreement should the guarantee be called on by the lender.

Subordination of debt

If the joint venture requires so-called mezzanine or additional funding to complete the project then the issue of subordination will arise. This issue will also apply if one of the parties requires supporting security over the property to protect its position, as is commonly seen in a contractual or investment joint venture where only one party is providing funds.

The subordination of debt and security can be a contentious issue, and the deed regulating the position between the lender and other parties can be heavily negotiated. To avoid a delay in obtaining funding for the project and incurring professional fees, the parties should seek to agree sensible terms for any subordination as early on in the process as possible.

"While most lenders will not entertain changes to their standard documents the package should work for all parties"

The key aspects to agree on are:

the level of priority of the debt being provided by the senior lender, and whether it will have unlimited priority
whether the junior lender is entitled to receive any payments while the senior debt is outstanding; this would be particularly important to a joint venture investor or junior lender that may be expecting the payment of an interest coupon on a monthly or quarterly basis
whether the senior lender should provide the junior lender with notice of its intention to enforce; a notice period may allow the parties time to settle the default in question or allow a junior lender the right to buy out the senior debt.

Obtaining funding for a property transaction is complex and each lender will have different criteria. This is intensified when that transaction is a joint venture as there are more parties involved in the decision-making process. To avoid increased costs and delays, it is therefore essential that the parties in the joint venture are organised and take good-quality legal advice at an early stage.

Matthew Grogan is a partner and property finance specialist at Thomson Snell & Passmore LLP

matthew.grogan@ts-p.co.uk