This can be partly explained by the rush into development lending in the last five years; developments failing against a backdrop of difficult market conditions for sale and refinance; and a growing recognition that some developers were not up to the task.
A recent High Court case illustrates the issues which can arise and the circumstances in which a lender will fail to recover losses from its monitoring surveyor.
Governors and Company of Bank of Ireland & Others v Watts Group (2017) was one of the first cases looking at the responsibilities of monitoring surveyors in development lending and provides important guidance as to good practice on when to lend and how to manage drawdowns.
It highlights development lending as an area with increased risk, a new litigation trend, and offers guidance on good practice.
Meagre profit margin
Bank of Ireland approved a £1.4m facility for a development of 11 apartments in York in 2007, £210,000 of which was for the land purchase.
Its customer was a special purpose vehicle (SPV) owned jointly by a key client and a development contractor, with the bank having a £20m exposure to its key client.
The lender relied upon a Savills report (who had already been commissioned by the borrower) for the loan approval and monitoring surveyors reports for loan drawdowns.
The cost of the development was around £1.8m and the gross development value (GDV) around £2m, leaving a profit margin of a mere £200,000 on the development, if all was successful and everything ran to plan.
Notably, the lending exceeded the bank’s own underwriting parameters on loan to cost, loan to GDV and site value to development cost ratio.
Post loan completion, the bank instructed an independent monitoring surveyor to report on the developer’s costs construction estimate, the developer’s build programme time estimate and the developer’s cashflow.
The report was intended to provide the bank with comfort as to the feasibility of the project before further drawdowns were sanctioned – an acceptable report was received and the bank advanced the drawdowns.
By 2009, the key client entered into administration.
This resulted in the developer becoming insolvent and the construction ceased and the bank suffered losses of around £750,000.
Bank of Ireland claimed its losses from the monitoring surveyor, who it said, had underestimated construction costs, the time required for construction and had failed to identify discrepancy between scheme drawings and planning permissions granted.
According to the bank, had they competently reported, drawdowns would not have been made.
On the expert evidence, the court concluded that the monitoring surveyor had not been negligent and it had received a fee of just £1,500, which suggested that it had not been expected to perform a detailed forensic analysis at that price.
The court did confirm that the bank could place reliance on the report and determined that the loss could have been recovered if negligence had been proven but this would have been reduced by 75% as a result of the bank’s own contributory negligence.
Many lenders only now appreciate how important continuous close monitoring of developments as they progress is, to ensure successful recovery.
However, there are a number of key lessons to be learned. Every lending piece should be underwritten on its own facts and circumstances and must meet documented tried and trusted underwriting criteria.
A monitoring surveyor does not underwrite the risk where criteria are ignored.
When instructing a monitoring surveyor, lenders should always provide detailed instructions which should outline exactly what is required. Following the first report, regular reports should be commissioned on the same basis and understanding.
It should also consider attending inspection to avoid confusion and misunderstanding.
Had the bank done so, then its prospects of recovering the loss of drawdowns would most likely have been good.
But that would not have resolved its major omission, which was to advance its facility based on the relationship with its customer and not its own lending proposition parameters.