Real estate projects in financial difficulty: Part 2
This article originally appeared on The Lawyer’s Daily website published by LexisNexis Canada Inc.
This is the second in a series of three articles that address issues when a real property developer becomes insolvent.
In the course of developing and building a real property project, the real estate developer will deal with a number of different parties, including the developer’s trades, the local municipality, secured lender(s), Tarion Warranty Corporation (Tarion) and purchasers. When the real estate developer runs into financial difficulties, the stakeholders in a project will have different objectives, and may take certain actions, as discussed below.
The developer’s objective is to get the project to a point where sales of units can be completed so that the proceeds therefrom can be paid to settle financial obligations; remaining proceeds are used as the developer sees fit. Where there are insufficient funds, the developer may not complete parts of the project that aren’t critical to achieve substantial completion or may take steps that result in a change to the appearance and design of the project. As well, the developer may look to minimize its exposure, including for obligations that were guaranteed personally by the developer’s principals.
The objective of trade creditors providing materials and labour is to be paid for the work they do. Trade creditors’ contracts may provide for progress billings to the developer and the trades expect timely payment of those invoices. If the developer fails to pay, trade creditors can file and register liens against the project in order to preserve their rights against the developer. The claim of a registered lien claimant can rank in priority to claims of unsecured creditors and, in some circumstances, may have priority, in whole or in part, over the claims of secured lenders. The lien claimant(s) may seek the appointment of a trustee pursuant to the Construction Lien Act (Ontario) to enable the project to be completed and units sold, with the net proceeds of realization used to pay claims based on their priority.
When approving a project, the local municipality verifies that the project aligns with its vision for the community. A municipality will require a number of things from the developer, such as performance bonds, engineering plans, architectural drawings and density and zoning details, and compliance with building, fire, safety, and other applicable legislation. The municipality may impose numerous conditions to be fulfilled, prior to registration of the project and commencement of the sale of units. When faced with an insolvent developer, it will insist that all of its requirements are met “to the “T” before allowing the release of any of the developer’s performance bonds.
Secured lenders make construction advances to a developer based on the developer’s projections of costs, revenues and profitability of a project. Prior to advancing funds, the secured lender will require that the developer sign a security agreement such as a mortgage, which will be registered on title to the property. When a developer defaults on the terms and conditions of said agreement, the secured lender will usually take steps to recover the advances it made. This may include the appointment of a receiver whose goal is to maximize realizations. This can be achieved by selling the property on an “as is” basis or completing and registering the project and then (i) closing existing pre-sales, or (ii) terminating existing contracts with purchasers and re-selling units at market prices.
Tarion’s primary purpose is to protect purchasers of new homes/units by ensuring that developers abide by applicable legislation and standards. Tarion will obtain bonds as security that the developer will meet its obligations pursuant to Tarion’s warranty program. Tarion may refund all or a portion of purchasers’ deposits if the development is not completed. In the case of an insolvent developer, Tarion will ensure that for completed projects, the deficiencies Tarion warrants are rectified prior to releasing the security provided by the developer. Note that Tarion only deals with residential properties.
The main objective for purchasers of residential property is to obtain title to their property at the agreed price. Recent case law suggests that when a developer becomes insolvent, purchasers may be required to pay the then current market price for the property to complete the transaction. Assuming they agree to close, purchasers want to ensure that all warranted deficiencies associated with the project are rectified by the developer and may look to Tarion for assistance. As set out above, the stakeholders in a real estate project have different and sometimes conflicting objectives and interests when a developer becomes insolvent. Our next article will discuss attempting to balance the differing interests of these parties.