Maintaining security of deposits


Share

In light of the recent change in NHBC policy wording, how can Registered Providers ensure that deposits released on exchange of contracts are repaid if the developer defaults or becomes insolvent?

Following months of economic turbulence and anticipation of market downturn, developers are increasingly asking Registered Providers (RPs) to release deposits on exchange in affordable housing deals to assist the overall project cash flows. Even in the good times this was fairly common practice and was considered acceptable by both parties as long as the deposit was adequately secured in some way. By releasing the deposit, RPs could leverage their relatively lower cost of capital to assist the developer's cash flow, usually in return for a slightly lower package price.

One of the most frequently used methods for securing repayment of the deposit was for the developer to include the optional pre-completion contractor insolvency cover under NHBC's Buildmark Choice warranty. The longstanding policy wording had until recently covered repayment of deposits or other payments already made under the contract, usually up to 10% of the contract value.

But for schemes registered with NHBC after 1 April 2022, a revised policy now applies and deposits are no longer covered. The official reasoning being that the previous policy wording was considered to be a moral hazard, incentivising excessive risk taking by RPs. The revised policy still offers cover for cost overruns where the RP steps in to complete the construction of the dwellings following insolvency of the developer, as this was assumed to be the key concern for RPs on development acquisitions.

Whilst NHBC have said that they will still provide security for released deposits on a case-by-case basis (by issuing a side letter to reinstate the previous policy wording), where this is not given, what other methods could RPs use to secure repayment of deposits if the developer becomes insolvent?

  • Parent company guarantee – depending on the corporate group structure of the developer, a guarantee from the main trading vehicle or ultimate parent company might provide sufficient covenant strength.
  • On-demand advance payment bond – usually given by a recognised financial institution, this will provide arguably better cover than NHBC once did, but may be prohibitively expensive for SME developers.
  • Legal charge over the whole or part of the site – if the affordable homes are being delivered relatively early compared to the remainder of the site, that land could be used as security for the deposit as long as it is independently deliverable and bears sufficient residual value.
  • Taking the land transfer at Golden Brick stage – although this may already be envisaged in a large number of transactions, until recently lower value deals were often simpler to structure on a turnkey basis with a released deposit. These could instead be restructured as Golden Brick deals to offset the cash flow disadvantage of not releasing the deposit.
  • Taking the land transfer up front – this could release the whole of the land price to the developer (not just the deposit) in return for a lower construction package price, but would be dependent on the VAT treatment of the land sale.

Whilst each of these alternative options would require some degree of additional complexity, that may become a worthwhile trade off in the absence of the more straight-forward solution of using NHBC pre-completion contractor insolvency cover.

But in all cases, RPs will likely be scrutinising developers' financial health with increasing rigour and may adopt more conservative payment profiles in light of the growing concerns over the risk of insolvencies in the housebuilder sector.

Insight

Landlord's Certificates under the Building Safety Act 2022 – what do landlords need to do?

Explore
Insight

Trowers' property litigation weekly update

Explore
Insight

Webinar: Solutions to current issues in the cost of living crisis

Explore
Insight

ESG Perspectives: A review of sustainability and impact investing with SHAPE Knowledge Services

Explore
News

Trowers acts for GreenSquareAccord on £400m sustainability bond

Explore
Insight

Webinar: Sustainability and the Capital Markets

Explore