A recap of development finance and assignment of construction documents
The assignment of construction documents is often an important part of any development finance transaction.
Ross Galbraith and Pippa Garden, both in our construction team, alongside Georgia Sproat, from banking and finance, explore the most common types of assignment used on such transactions and revisit the key Mailbox case from 2018.
What is an assignment?
An assignment is the transfer of a right from one party to another. In construction, the right transferred may be one or both of the following:
- The benefit of a contract, transferred from an original party to the contract to another person, who was not a party to the contract; or
- A right to bring proceedings, whether in court, by arbitration or by adjudication. In this article, we will focus on the assignment of construction contracts from one party to another in the development finance context.
Why assign?
As a condition precedent of providing any finance to a developer, funders will typically require either collateral warranties from the main contractor, consultants and sub-contractors or an assignment of any existing collateral warranties from the same parties (which is more relevant when there is a refinance involving an existing funder who already has warranties in its favour).
A funder may also take a security assignment or an assignment by way of a charge of key construction documents (such as building contracts and consultant appointments).
These are usually expressed to be absolute assignments, subject to a proviso for reassignment on full discharge of the secured liabilities.
Both types of assignment will allow the funder to potentially enforce their rights under the relevant warranty and/or construction documents, should the borrower default on the loan.
The type of assignment will determine whether the funder holds a “legal” or “equitable” assignment. The key differences between legal and equitable assignments are that legal assignments provide greater protection and allow the funder to enforce specific rights in the contract and bring proceedings in its own name against the relevant party.
Legal or Equitable Assignment?
Legal Assignment
A legal assignment is a formal transfer of rights. To be considered a legal assignment, section 136(1) of the Law of Property Act 1925 (‘LPA 1925’) must be complied with. This requires the assignment to:
- Be in writing;
- Be absolute;
- Not purport to be by way of charge only; and
- Expressly and formally notify the debtor of the original party.
A legal assignment confers greater legal protection as, once the rights are assigned, the assignee can enforce them directly without needing the participation or permission of the original party.
No particular form of notice is required for a legal assignment, as long as it is clear that there has been an assignment.
Where a funder requires a legal assignment, the assignment document will usually contain a form of notice and acknowledgement and a requirement for the borrower to serve notice on counterparties to the contracts being assigned in order to perfect the assignment.
When a funder is assigned the benefit of a collateral warranty, this will generally be a legal assignment and the funder will directly be able to enforce its rights against the relevant contractor, consultant and/or sub-contractor.
Equitable Assignment
Where the formalities required under s136(1) LPA 1925 are not met, but there is still an intention to transfer some or all of the rights, the assignment will usually have an equitable effect.
Unlike a legal assignment, an equitable assignment is not required to be in writing, notice to the debtor is recommended but not mandatory and partial rights can be assigned.
An equitable assignment provides fewer legal protections than a legal assignment, as the assignee may need the assignor to join in any legal action to enforce the rights.
Despite its weaker legal status, an equitable assignment is still enforceable through the courts.
When the funder takes a security assignment or an assignment by way of a charge of key construction documents (such as building contracts and consultant appointments) a lender will typically seek to ensure this is a legal assignment.
However, in some circumstances, a lender may accept an equitable assignment – for example, only serving notice of the assignment if there is an event of default at a later stage but this comes with some risks of not perfecting the assignment at the outset
Mailbox (Birmingham) Ltd v Galliford Try Construction Ltd
The Mailbox case was a key case in determining the differences between both legal and equitable assignments and the dangers of when an intended equitable assignment actually results in a full legal assignment.
Galliford Try Construction, the defendant contractor, had agreed to refurbish a mixed-use retail and office space in Birmingham. The contractor, and the claimant employer, Mailbox (Birmingham) Ltd, entered into an amended JCT Design and Build Contract.
Most of the work on the project was already carried out but, on 1 March 2016, Mailbox (Birmingham) sought to terminate the contractor’s contract.
A dispute then arose between the parties as to who was responsible for the delay, liability for liquidated damages, the proper valuation of the final account and whether Mailbox (Birmingham)’s decision to terminate Galliford Try Construction’s contract was lawful.
On 19 August 2016, Mailbox commenced adjudication proceedings.
Following the adjudicator’s decision to award liquidated damages and interest, Galliford Try Construction sought to challenge Mailbox (Birmingham) on the basis that they were not entitled to commence the adjudication proceedings in their own name as they had assigned the benefits of the building contract to Aareal Bank.
Mailbox (Birmingham) tried to argue that whilst there may have been a charge in favour of Aareal Bank, there was no assignment and, even if there had been an assignment, there was a re-assignment to Mailbox (Birmingham) on or before the notice of adjudication.
The Technology and Construction Court (TCC) had to decide whether initially, there had been an assignment or charge in favour of the funder and, if there had been an assignment, whether a valid reassignment had taken place so that Mailbox (Birmingham) could bring proceedings in their name.
The TCC reviewed the language used in the assignment document and in the notice given to the defendant. They held that the initial assignment to Aareal Bank was an equitable assignment, and that the re-assignment was also valid and, importantly, had taken place before Mailbox (Birmingham) sought to commence adjudication proceedings.
Ultimately, Mailbox (Birmingham) proved that it had the right to bring proceedings in its own name and that the adjudicator had jurisdiction to determine the dispute. As a result, the adjudicator’s decision was upheld.
From a practical perspective, the Mailbox case serves as an important reminder to check and evidence the date of any assignment or re-assignment.
In this case, the court made it clear that the adjudicator’s decision would not have been deemed enforceable had the re-assignment to Mailbox (Birmingham) taken place after the notice of adjudication.
Similarly, the adjudicator’s comments in Mailbox (Birmingham) Ltd v Galliford Try Construction Ltd highlight that to ensure a legal assignment is not created unintentionally, it is important to understand a funder's requirements and, specifically, what type of and how the assignment is being created.
Practical takeaways
- Understand what security the funder requires from a construction perspective – does the funder require a full legal assignment of any collateral warranties? Does the funder require a security assignment or an assignment by way of a charge over any of the construction documents?
- Check whether you are able to take an assignment of the relevant warranty and/or construction document. For example, the standard form JCT contracts do not allow for assignment without the contractor's consent.
- From a borrower’s perspective, be careful not to give away more than you intend to - if you are assigning all of the benefits via a legal assignment, be aware that you may no longer have the ability to enforce the rights under the contract. On redemption of any loans be sure to document the re-assignment of any rights.
- As a borrower negotiating an assignment, be cautious of funders requiring you to procure an acknowledgement to a notice of assignment – this should be limited to (at the most) using best endeavours to do so and preferably reasonable endeavours, given you cannot force a third party to acknowledge a notice.
- When drafting any debenture or assignment document, ensure clear wording is used to distinguish between an absolute legal assignment and a security assignment, with a right to re-assignment on settlement of the debt.
- If you are a funder, ensure your security is perfected by requiring borrowers to serve notice on counterparties to an assigned contract and registering the assignment at Companies House within the 21-day limitation period.
For more information about the assignment of construction documents, or if you have any questions about construction law in general, please contact Ross Galbraith using [email protected] or 0191 211 7999.
For any queries about security and development funding please contact Georgia Sproat using [email protected] or 0191 211 7866.