An increased frequency of buyer-funded property developments failing to complete is leaving investors out-of-pocket, and rendering law firms liable for the lost sums. With many insurers either applying additional excesses and charging significant premiums, or declining to renew cover, firms should take precautions to avoid becoming involved with similar schemes.
Buyer-funded development pitfalls
‘Buyer-funded’ developments are property developments partially funded by the purchase deposits of individual buyers, as opposed to a commercial lender. Buyers will purchase the properties off-plan, including a substantial deposit which is used to fund the project’s completion. This may include costs for construction, marketing, or sales commissions.
Such schemes have become especially popular in the wake of the 2008 financial crisis, since when developers have found project finance from commercial lenders increasingly hard to secure. Buyers of such properties, meanwhile, are often overseas investors attracted to the scheme by the promise of high returns in rental income following the property’s completion.
In reality, however, many buyer-funded developments fail to complete. Where such schemes do fail, it may be due to a variety of factors, including unforeseen costs, failure to secure planning permission, or fraud. In all cases, buyers will have contributed considerable sums of money without a product to show for it.
Perhaps the most high-profile of these cases to-date was the stalled Angelgate development (opens a new window) in Manchester, billed as a project to build 344 luxury apartments. Nevertheless, similar schemes have also taken the form of student accommodation developments and, more recently, residential care homes.
Solicitors’ liability in the event of incompletion
Claims against the law firms that participated in operating these schemes have become prominent in recent years and, in the vast majority of cases, solicitors have been found liable to the investors. Typically, this will be due to a failure to give sufficient risk warnings with regards to the investment.
Crucially, the scale of these claims is often significant, with solicitors held liable both for the initial investment, and for the guaranteed investment percentage first promised to the investor. With lawyers often operating for multiple clients within a single development, a single project incompletion can also result in multiple liabilities.
As a consequence, professional indemnity insurers have paid out many tens of millions of pounds in the UK to resolve huge swathes of claims relating to such developments. Accordingly, the majority of insurers now refuse to provide insurance to any law firm currently engaged, or with a track-record of involvement in these kinds of developments.
Solicitors should also beware potential conflicts of interest arising from buyer-funded development schemes. In one example reported earlier this month, a solicitor was fined more than £45,000 for misconduct (opens a new window) by the Serious Fraud Office, after they acted on behalf of both the developers and buyers of properties in a fraudulent off-plan development scheme. The alleged successor of the solicitor’s now-defunct firm is also facing a £55m professional negligence lawsuit.
Warnings for law firms
The dangers involved with buyer-funded development schemes are significant, and involvement with them is likely to dramatically change how insurers view a firms’ risk exposure. Predictably, this is likely to lead to a considerable increase in insurance premiums and change in excess structure.
To limit rises and safeguard access to cover, firms involved in development work of any kind should remain vigilant with regards to the role of buyer-funded deposits.
Measures to mitigate against incompletion-related liabilities include:
As a rule of thumb, avoiding projects such as: off-plan, new build, refurbished or buyer-funded property development units, where buyer deposits equal greater than 10% of the total project funding
Seek additional protection for deposits where the contribution exceeds 10%
Evaluate and give risk warnings to the client that the law firm cannot guarantee any investment income
For further information, please visit our Lockton for Solicitors (opens a new window) page, or contact:
Arjun Rohilla, Vice President
T: +44 20 7933 2987