by Simon Hardwick
Is your lawyer a functionary whom you call on merely to generate lengthy and obtuse documents? Or is he an evil necessity for when things go wrong? This article examines the lawyer’s changing role.
Current economic trends and the recent rises in interest rates have caused many in the property sector to review the outlook for their industry. There is gloomy talk in the commercial market of a recession at least as serious as that presently being experienced by the housebuilders. Whatever one’s view about these dire predictions, prudent developers are now reviewing their businesses to assess how well they are placed to cope with a downturn in the market. Many are coming to the conclusion that in times of economic uncertainty they need to operate in ways which would have been considered unnecessary in the optimism of the boom years. One area where important changes are taking place is in the role of the lawyer in the developer’s team.
Solicitors have generally been regarded as having only a peripheral part to play in the property development business. In the main, their involvement has been transaction based, focusing on the documentation for individual developments: their brief to implement decisions which they have not participated in reaching. It has also been common for developers to use the services of a number of different firms of lawyers, selecting whichever is considered to be the most suitable “horse for the course”.
The effect of the use of legal services in this manner is that the solicitor frequently lacks overall knowledge of his client’s business affairs. Without this, it is impossible to gain a proper understanding of the developer’s needs. What may seem a perfectly reasonable approach to resolving a problem associated with a particular project may not be the best answer to the overall health of the developer’s business.
A frequent criticism of solicitors is that they find problems — not solutions. Their advice is reactive rather than proactive. All too often this is true. However, the fault does not always lie entirely with the lawyer. In the past developers have been apprehensive about the possible cost of their advisers spending time to understand the whole of their business and of becoming involved in projects at an early stage. This concern is natural when the commercial climate is such that the worst risk is seen to be incurring fees for abortive transactions. In a more difficult market, where the risks are more complex and problems potentially more serious, this approach can prove to be penny wise and pound foolish.
A more businesslike approach
This point is now recognised by the most successful developers. They are demanding from their lawyers an altogether more comprehensive, businesslike approach. The solicitor who is able to satisfy these requirements will be expected to play an important, integral role in his client’s business. He will be part of a team of key advisers. This is a role to which he ought to be well accustomed — co-ordinating different areas of expertise and contributing his skills to a team with a common purpose. Property lawyers should be able to work alongside surveyors, bankers, accountants, architects, quantity surveyors, engineers, project managers and builders — and be able to talk their language.
The question from those unaccustomed to this approach is “what should I expect my solicitor to be doing for me?”. The answer is — much more than you think.
The solicitor’s first and traditional role is dealing with the sale and purchase of land and with the normal range of legal problems associated with any development projects. Here the essential requirement is that the lawyer is able to look at the project through the developer’s eye. This will enable problems to be anticipated and overcome at an early stage. A fairly recent example of the importance of this approach is the decision in the courts that a developer can be prevented by an injunction from allowing the boom of a tower crane to pass through the air-space above land owned by someone else. If this requirement is identified before a site is purchased, any necessary rights can normally be acquired relatively cheaply. Alternatively, the design of the building or method of construction can be planned so that neighbouring air-space is not infringed. If, however, matters are left until the development has begun, it may be that those solutions are no longer available. This could leave the developer at the mercy of the neighbouring owner to extract a substantial price for his co-operation.
Developers can be their own worst enemies
As always, good advice at an early stage is essential in order to spot and avoid this type of problem. Prevention is always better than cure. Even in this basic area, developers can be their own worst enemies in making sure that they get the possible service. All too frequently, weeks of negotiation will lead to instructions being given to the developer’s solicitors out of the blue, demanding that contracts be exchanged within 48 hours. This allows little time to process the legal paperwork and obtain the necessary searches. It certainly gives virtually no chance for the lawyer to properly understand the intricacies of the scheme and any special problems which might be associated with it. It would be much more sensible for the developer to involve all of his team at an earlier stage. The costs of doing so are likely to be far outweighed by the ability to identify and resolve problems before a deal has gone too far. Many firms of solicitors now recognise the importance of this and charge nothing, or only a nominal fee, for abortive work.
The second area where the property lawyer should be expected to fulfil an important role is in assisting with the co-ordination of funding and (increasingly) refinancing. Development finance can vary in complexity from simple clearing-bank or building-society borrowing to very complex syndicated loans or multi-tier debt with equity participation. Property lawyers ought to have experience of most types of funding schemes and be able to assist in the negotiation of suitable terms for particular developments.
Perhaps of greater importance is the role that lawyers can play when things begin to go wrong. The rate of inflation in building costs over the past few years, combined with depressed residential and slowing commercial markets, has led to the need for some developers to obtain extensions to their facilities. It is likely that this will become increasingly common if the more pessimistic predictions of recession prove to be accurate. This task needs a great deal of careful co-ordination if bankers’ confidence is to be retained and inadvertent breaches of gearing covenants or other loan conditions avoided.
The essential requirement to allow this to happen is for the developer to be willing to permit his lawyers, accountants and principal bankers to work closely together and give them a full picture of what is going on. They are likely to have knowledge of similar problems suffered by others and be able to adopt an objective and comprehensive approach. The writer’s recent experience is that some overseas lending institutions who have entered into the UK property market during the boom years sometimes need to be persuaded that their best, long-term interests lie in supporting their borrowers in difficult times, rather than in realising their security and running. Responsible lenders, are, however, generally willing to negotiate increased facilities or extensions to loans if they have confidence both in the developer and the project in question. The right advisers can help to determine what concessions can sensibly be sought and how to present such proposals.
The need for fire-breaks
The third area in which the property lawyer should be expected to fulfil an important role is in the protection of the developer’s business against unforeseen disasters. It may be necessary to examine the client’s corporate structure to assess how effective it is to limit the impact of the failure of one development or division on the group as a whole. The protection can be achieved by dividing the developer’s business either into separate parts which are split either geographically or by type of work, or into separate companies for separate projects.
Those who have not yet considered the introduction of such a scheme should do so. It is, however, important to do this in a way which does not result in tax disadvantages or the loss of confidence of bankers and builders. Those who do already have such a scheme in place should review with their lawyers how the fire-breaks may have been bridged by the provision of intercompany guarantees. Are those guarantees still really necessary? Can they be withdrawn or reduced in scope without prejudicing the ability of the group to continue to function effectively?
All too frequently one discovers that schemes which are funded through what is believed to be “non-recourse financing” do actually give very real recourse by the lending bank against the parent company. This is due to the provision by the developer of guarantees for interest or cost overruns incurred by its subsidiary. When given, these guarantees are often thought to involve very little risk to the parent. The reality is, of course, quite different — as is now being experienced by residential developers in London’s Docklands. While building costs continue to escalate, the market for units at any price has all but vanished. The lack of a market can prolong the sales programme to such an extent that the accumulated interest covered by an interest guarantee can create a very substantial liability for the parent. The predictions of oversupply in the City office market give rise to concern that similar problems could occur in that sector.
Developers who have already given guarantees of this type need to assess their potential impact on their entire business. It is essential to ensure that extensions of facilities do not unnecessarily increase the exposure under the guarantees. New borrowing must be arranged wherever possible on terms that minimise the risk to the group of the failure of the scheme. The right time to implement any protective changes in a developer’s corporate structure or to secure the removal of cross guarantees is when business is thriving. If the task is left until problems are already apparent, it is frequently too late to do anything about it. The successful developers are already using their lawyers to make sure that they are in good shape to survive unforeseen disasters.
The fourth area in which more is being expected of the property lawyer is in helping directors to make the right decisions when things do go wrong — both with specific projects and to more general business problems.
The benefits of appropriate advice at an early stage in solving problems relating to a particular development are, surely, obvious. It is, however, surprising how often a project manager will spend weeks pursuing the wrong solution when a simple telephone call to his solicitors would quickly identify a better answer. If this happens in your company you should ask yourself whether you and your staff are yet using your lawyers in the right way.
Directors’ liabilities involved
It is in the realm of more general business problems, however, that the need for proactive legal advice assumes particular importance. This is because of the effect of the introduction of the Insolvency Act and the Company Directors’ Disqualification Act in 1986. The wrongful trading provisions in section 214 of the Insolvency Act apply to any person who is or has been a director of a company which is placed into liquidation. The director can be ordered to make a personal contribution to the assets of the company if:
(a) The company is in insolvent liquidation;
(b) At some time before the commencement of the winding-up proceedings, the director in question knew or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation; and
(c) That person was a director of the company at that time.
The unfit director provisions in section 6 of the Company Directors’ Disqualification Act allow a court to disqualify a person from being a director or involved in the promotion, formation or management of a company for a period of between two and fifteen years if:
(a) He has been or is a director of a company which has at any time become insolvent; and
(b) is conduct as a director makes him unfit to be concerned with the management of a company.
The effect of this legislation is to expose the director to the risk of personal sanctions if his business goes wrong. It is therefore no longer possible for developers to put their heads in the sand when things are going badly. They should require careful advice at an early stage to ensure that their actions do not expose them to the risk of personal liability or disqualification.
Suggested action
If you have recognised the need for changes in the way you use your lawyer, but have not yet implemented them, what can you do?
First, you must decide what you want your solicitor to do for you. Second, you should talk to your present lawyers to find out whether they have the skills and resources to suit your needs. It is unlikely that a provincial solicitor specialising in divorce work is going to be able to give good advice about sophisticated property problems. On the other hand, you are unlikely to benefit from using a major City firm if all you want is for your lawyer to process simple sales and purchases. Third, make sure that your lawyer knows what you want and that your principal contact partner is somebody who is on your wavelength. You will never get proactive advice unless you are dealing with someone who you can talk to — and who can talk to you. Fourth, once you have found the right lawyer — stick to him. You should get a much better service at a keener price if all your business goes to one firm of solicitors, rather than being spread among a number of different firms, none of which sees your business as being particularly important.
Involve your lawyer in what you are doing and explain what you are trying to achieve. He will feel part of your team and will want to contribute to your decisions. Lastly, please remember that your lawyers are human beings and not machines.
They will respond to praise for a job well done, to being treated with consideration and being paid promptly. They will react badly to being made to work all night on a job that is not really urgent and to being kept in the dark until the last minute. Remember, as with most aspects of business life, you will usually get out of your relationship with your solicitor only as much as you are prepared to put in.
The threat of more difficult times ahead for the property industry has meant that many developers are now looking for more from their lawyers. Those who have not yet recognised the important benefits that can be obtained from involving their solicitors in their business in a proactive manner should think again.
Otherwise, they may find that the competition has a crucial head start.
