Joint ventures between Registered Providers and developers are a valued route to unlocking sites and funding. But the basics must be right, say Lucy Grimwood and James Duncan.
Joint ventures (JVs) between Registered Providers (RPs) and developers are nothing new. Indeed, there can be natural synergies, and the Regulator’s approach seems to be relatively positive. In its October 2021 risk profile, it noted that JVs “can represent effective ways for providers to deliver key services and… value for money”, whilst also noting that entering into contracts with third parties, such as JVs, exposes RPs to counterparty risks and can reduce control over the quality of delivered services.
So it’s important to get the basics right. What are the key considerations for a good JV foundation, and how do you get off to the best start? There is lots to think about, and a robust risk assessment of the proposed partner(s) should be made early.
Two key considerations, over and above the viability of the development opportunity itself, are structure and funding.
Structuring the Joint Venture
Careful and early consideration should be given to the legal structure. Broadly speaking, Joint Ventures are either structural or contractual.
Structural Joint Ventures – the Limited Liability Partnership (LLP)
This structure is frequently selected for JVs between RPs and developers. Regulated by the Limited Liability Partnerships Act 2000 (LLPA 2000), LLPs have separate legal personalities so can enter into contracts and grant security. As the name hints, liability is limited, but as an LLP does not have fixed shares it is a more flexible structure which more easily allows different management, economic and contribution rights between members. One member might contribute land, another development finance and a third development management for example. Differing economic returns can be structured more easily within an LLP. This can also be helpful when considering whether the JV entity is bound to comply with public procurement rules.
LLPs are also (usually) tax transparent – whilst the partners are taxed directly on their profits, the vehicle is not taxed at all. This might be advantageous where participation in a limited company by a JV partner who would not otherwise be subject to tax (such as a RP itself) can have adverse tax implications.
The JV partners should enter a bespoke members/LLP agreement, otherwise the default provisions of the LLPA 2000 apply, which won’t cover everything and places specific obligations on members.
Consideration also needs to be given to the accounting treatment for JV LLPs; if an LLP is consolidated with one of its majority members, this may not achieve the ring-fencing originally intended and can bring liabilities “on balance sheet”.
There are other legal structures available to JVs (such as limited companies or community interest companies). However, whilst these structures may be appropriate in some situations, they can have various limitations or drawbacks (including specific tax considerations) and should be considered carefully.
Often a JV may be a master scheme where a number of different sites will be developed and/or managed by the JV. In this case care needs to be taken, for example to ensure the liabilities associated with each site are appropriately ring-fenced.
Contractual Joint Ventures
In a contractual Joint Venture, there is no separate legal structure for the JV, and one JV partner holds the land with the other sitting behind it. This might be preferable for a number of reasons. It may address procurement hurdles, for example if planning permission can only be granted to certain pre-approved entities. Other potential advantages may include greater flexibility, with none of the additional statutory reporting obligations that apply to an LLP.
Disadvantages can arise where one party contributes funding or services but has no direct asset or land ownership. Their ability to obtain appropriate security can become more challenging, particularly if third party funders and/or tax efficient structures are involved and need to be navigated.
Contractual JVs are usually documented by way of a collaboration or development agreement; these documents require careful consideration to ensure that the non-landowning entity is adequately protected, especially if it is providing funding for the development.
As a contractual JV cannot raise finance in its own name, seeking third party funding may be trickier than for a structural JV. For example, the borrowing entity (likely the JV partner owning the development property) may have pre-existing debt, including a floating charge; this could on default settle over the assets of the JV partner and relevant development, effectively blocking out the non-landowning JV partner. Diligence is key.
Funding the Joint Venture
Another key consideration is how the Joint Venture will be funded. There are a number of options.
Joint Venture partners funding
Joint Venture partners typically provide some of the funding, usually debt (i.e. members loans) and/or equity. Key points must be agreed early. For example, when and how should the JV partners provide further funding? What happens in the case of cost overruns, or if a JV partner doesn’t meet future funding calls? Members’ debt contributions will also need to be subordinated to any senior lenders, with (if secured) appropriate intercreditor arrangements.
Senior debt from a Joint Venture partner
Joint Ventures can be funded by a member, often the Registered Provider, providing a priority loan to the JV. This can be a good option but care must be taken to protect the lending entity. The following will need to be considered.
- Approach: to comply with their charitable purpose restrictions, non-profit RPs acting as lenders should be able to demonstrate the transaction is consistent with their objects or advantageous to them, any perceived risk is manageable, and there is a commercial benefit. This usually means lending on arms’-length terms, with the RP treated as a third party. What this means in practice depends, but will likely include a commercial rate of interest and “usual” lender terms. This requires careful balancing, given the commercial relationship between the two JV partners as 50/50 equals in the JV.
- Security: careful diligence is also required here. Has the JV previously charged that property, and if so, which security would rank ahead? And is there sufficient value in the available security? Not always; if the development is being undertaken by way of a short-term building lease then the lending entity may not be able to accept this as security.
- Practical considerations: for example, the lending entity should consider what controls it wants over the development and ensure it has proper processes to manage this. How will it approve drawdown requests? If a monitoring surveyor is required, who pays for this? What happens if the JV defaults? Any prudent lender knows how to “get out” before it “gets in”; how does this change the dynamics between the JV partners? Will the RP be taken advantage of because of its known financial resources and/or reputation? And remember that a JV partner’s rights won’t automatically be held by it as a lender, and vice versa.
- Source of funds: the lending JV partner should check at an early stage if the funding is permitted in accordance with the purpose provisions and any restrictions in its finance documents. Any lender consents should be requested as early as possible.
Once the lending JV partner is confident it can proceed, key terms should be documented. A detailed term sheet should limit subsequent misunderstandings.
Third party debt
Depending on the legal structure chosen, third party lenders will typically require fixed and/or floating charges over the JV’s assets – including over the relevant land, key contracts, appointments, insurances and possibly bank accounts. JV members may also be required to guarantee the JV’s performance of the debt, and/or secure JV interests; before doing so, JV members must check this is permitted, for example under their constitution and/or existing negative pledge arrangements.
If third party funding is contemplated, JVs should be established with this wide scope of security in mind. It is also important that funding is not negotiated in isolation; for example, consideration should be given to an enforcement scenario, particularly regarding the JV’s exit and change of control provisions.
Standard form documents
Standard, short-form loans issued by third party funders can be attractively simple, but such debt is often uncommitted (meaning no obligation to fund) and/or on-demand (meaning repayment can be demanded at any time); neither of which may be acceptable. As always, understand what is being entered into and what would happen (practically and legally) if there are bumps along the road.
Sustainable finance is on the rise
All entities will soon likely require their own sustainability policies – including JV entities, where such policy should be defined and maintained by the JV itself, referencing the relevant development, not simply relying on the members’ broader ESG strategies. Green/social finance where the debt proceeds must be used for a green/social purpose may be appropriate, depending on the development, but sustainability-linked finance may work better for longer-term developments. If funding comes from sustainable finance on-lent by a JV member, restrictions may apply. All requires careful consideration.
Conclusion
These are just some of the many considerations and potential challenges for RPs entering a JV with a private developer. As with any commercial relationship we suggest seeking legal advice before discussions progress, in all relevant areas – including property, finance, tax, corporate, construction and planning (to name a few). WS’ cross-sector Social Housing group offers comprehensive, multi-discipline proficiency in all relevant areas, and we would always be pleased to have a discussion or provide a view.