Following a recent slowdown in construction activity and rise in construction bankruptcies in the UK, lenders are applying greater scrutiny when deciding which projects to fund. As such, developers are under increasing pressure to meet the lenders’ insurance requirements. If these are not met, developers may face difficulties in progressing their project, potentially leading to the inability to realise the project entirely.
Compliance with insurance agreements
As part of a facility agreement with a lender, the developer will typically be required to meet various obligations in respect of Construction All Risks, Loss of Rental Income, and Third Party/Public Liability insurance (as a minimum). These requirements are prescriptive and can only be complied with fully by procurement of a project specific insurance programme – which should be taken out by the developer.
It is not unusual for a developer to rely on their contractor to procure insurances, leveraging the contractor’s annual policies for the project, despite the associated commercial risks. Beyond the general risks to the developer, relying on a contractor’s existing insurance policies would result in non-compliance with most provisions of the Facility Agreement, namely:
Procurement of Loss of Rental Income insurance
Incorporation of specific lender requirements, providing access/benefit to the insurance policies in place (such as joint named insured, first loss payee, freedom to assign, waiver of subrogation against lender/tenants etc)
Accompanying risks
Failure to meet the insurance requirements would be considered a breach of contract and could result in significant implications – both legal and financial. These risks not only threaten a projects progress but could also compromise overall viability and financing of the development. Below are some of the potential consequences of non-compliance with insurance obligations:
Project delay/suspension – without the required insurance coverage, construction or other project-related activities could be halted, resulting in costly delays. This can also trigger contractual penalty clauses tied to missed deadlines and extended timelines, adding further financial burden.
Additional insurance costs – if the chosen insurance arrangements do not comply, it is likely the lender will require additional/replacement coverage which would need to be procured in a reactive manner. This typically necessitates a new insurance programme to cover the project’s risks, which may result in higher costs due to the nature of the procurement and, depending on how far the project is progressed, limited or non-availability of coverage.
Reputational damage – loss of credibility because of non-compliance and potential resultant delays in project delivery could harm a developer’s reputation in the industry. Lenders, insurers, and future business partners may view the developer as a higher risk for proposed projects, which could hinder their ability to secure favourable terms in subsequent ventures. A tarnished reputation could also reduce stakeholder confidence and impact relationships with subcontractors, investors, and the broader community.
Amendment to terms and conditions of the loan – as finance agreements mandate, the comprehensive insurance requirements are to be procured and maintained throughout the duration of the project. Failure to comply may lead lenders to amend the loan terms – possibly increasing interest rates, shortening repayment periods, or introducing more restrictive conditions. This could adversely affect the project’s financial structure and profitability.
Renegotiation fees/penalties – in addition to less favourable terms and conditions, lenders may impose fees and penalties. This is because of the need for renegotiation arising from non-compliance with existing requirements. In more severe cases, the developer could face the total withdrawal of financial support, as lenders often view adequate insurance coverage as a vital safeguard. This could endanger the continuation of the project and potentially result in its termination.
It is therefore crucial that the developer ensures full compliance with the insurance provisions from the outset to avoid any potential consequences.
Recommendations
To eliminate the risk of non-compliance, we recommend early engagement with a specialist insurance broker to thoroughly review the proposed requirements.
Upon completion of any negotiations and reaching an agreement on the facility agreement terms, an Owner Controlled Insurance Programme (OCIP) can then be implemented, incorporating all of the necessary cover requirements to ensure compliance.
For more information, visit our Global Real Estate and Construction (opens a new window) page or contact your Lockton representative.
