Does the coronavirus pandemic threaten forward deals and forward leases?
In recent years, forward deals have increasingly been concluded to capture projects at particular prices already during the development phase. Accordingly, also investors are increasing tending to invest directly or indirectly in project developments by way of forward deals. In forward deals the investor already buys into a property during the project development phase and then pays either in instalments depending on the progress of the construction (forward funding) or on completion (forward purchase). These types of forward deals have been concluded either as an asset deal or as a share deal.
But this seemingly risk-free transaction model is now boomeranging on both sellers and buyers, because now precisely the risk to which forward deals are so vulnerable due to the long period between entering into the contract and completion of performance manifests itself. The risk of the coronavirus pandemic can affect the contract in a variety of ways, whether it concerns compliance with contractual deadlines, the assertion of contractual penalties, the maturity of advance payments or down payments, or the impact of interruptions of supply or subcontracting chains, as well as entitlement to additional remuneration and compensation, problems in fulfilling initial rental guarantees, losing certain tenants, but also the burden placed on the balance sheets of the target company and the financing of the target company etc. Now, suddenly it also seems that even generously chosen long-stop dates become problematic, while sellers and buyers – but even financing banks – wonder whether they are still bound to their corresponding obligations.
Forward deal with precautionary clause
Obviously, forward deals are complex contracts in which the risks must not only be discussed but also regulated in the contracts, since there is generally no direct legal standard contract type applicable for the forward deal. Therefore, anyone who has included clauses on ‘acts of God’ or ‘force majeure’, or on obstructions or interruptions to the project, has already established reliable rules for the coronavirus pandemic that can help to some extent. After all, at least as regards contracts entered into before March 2020, none of the parties expected to face a coronavirus pandemic.
Forward deal without precautionary clause
Things become more difficult, though, for contracts that have not made provision for the typical risks of project development, or where promises have been made that are beyond the statutory classification of risks. It is important to keep in mind that a forward deal is usually a combined-type contract which may consist of a contract for work and a sales-law (and/or company-law) part. As a result, it is necessary to analyse in detail which legal rule applies to certain defaults (“combination method’ or ‘absorption method’/’focal point theory’).
Assuming that the coronavirus pandemic is indeed to be qualified as a force majeure event and was not foreseeable and that the pandemic was the cause of the defaults, the statutory provisions give sufficient scope to develop a proper solution regarding time extensions, absence of liability or absence of default on the part of the project developer. However, not every labour shortage at project participants can be classified as force majeure, nor can higher costs of materials, subcontractors or financing, etc.
In the same way, ‘harsh’ interference or even orders issued by the buyer to the seller should be avoided as long as the legal and factual situation is not yet clear and, above all, as long as the length of the pandemic is not foreseeable.
Particularly serious problems arise for contracts in which the seller has assumed certain further risks, either because a guarantee has been assumed unconditionally and the seller is liable even without fault, or because a withdrawal from the contract has been provided for in the event that, for whatever reason, the contract has not been consummated by a certain point in time. In those cases we have to go deeper into the legal box of tricks. The catchwords here are ‘atypical risks in case of guarantees’, ‘temporary impossibility of performance’ and, as a result thereof, (temporary) absence of maturity, among other things. On the other hand, merely invoking a ‘frustration or disruption of contract’ does not always help, because often two crucial points are overlooked as far as this legal remedy is concerned: first, the contractual or statutory risk allocation and second the issue of unreasonableness for the party invoking it, taking into account all the circumstances of the case.
Also, it is important not to forget the timeline that remains for the parties to such a contract. The seller is often in a conflict between the buyer on the one hand and its subcontractors or the contractors appointed by the target company and its financial institutions on the other hand. He may even have assumed personal liability. Therefore, in many cases it is advisable to seek consensual solutions.
The situation is similar with respect to forward leases (also referred to as ‘letting straight from the drawing board’). In case of forward leases the building principal already makes sure during project development that the future tenant structure meets its requirements, i.e. by entering into tenancy agreements even before the rental property is ready for tenants to move in or even before it is built. But also in the case of existing properties, rental units are modified to meet the specific needs of certain tenants; this is usually accompanied by a fixed handover date of the rental property.
Both for forward deals and for forward leases, the necessary construction contracts must be entered into which reflect the content of the relevant contract.
With respect to forward leases, due to the coronavirus pandemic, similar problems to those described above for forward deals arise before handover to the tenant. Here, too, the decisive factor is whether the contracting parties have regulated typical risks of a project development in the contract or not, or whether they have even taken on more extensive risks than the law requires. In the case of a forward lease, however, it is also important to consider whether the handover date is to be regarded as a fixed-date transaction and whether this leads to the statutory guarantee liability of the landlord and building principal towards the tenant.
Any questions? Please contact: Dr Stefan Weise
Practice Group: Real Estate Investment Group