Development Agreements - how do they work?
A building development agreement is used to govern the rights, responsibilities and performance obligations concerning a development project, generally between a land owner and developer.
Unlike a domestic building contract or agreement for sale of land, a development agreement does not usually come in a standard format.
Land developments range from small residential subdivisions to large-scale multi-use complexes - consequently, the content, terms and provisions of a development agreement can vary significantly from project to project.
Common agreements typically include the following:
• A sale development agreement whereby the landowner sells the land to the developer but maintains control over the development.
• A joint venture agreement between the landowner and developer on a single project basis, whereby the parties retain their respective assets, contribute to the project and take shares of the product but do not share profits.
• A services development agreement whereby the developer is engaged to carry out the project including its sale and marketing; the landowner retains title to the land; the parties agree on the allocation of construction and other costs; and the developer accounts to the landowner for the agreed profit after the individual units are sold to the eventual purchasers.
A party contemplating the development of property with another person or entity should have a formal written agreement in place, no matter how small (or large) the project.
The arrangement needs to balance the parties’ respective interests which will be commercially driven. The developer will generally be concerned with minimising initial outlay, sharing risk and avoiding unnecessary stamp duty and other taxes. The landowner will pursue maximum net return on the land with minimal development costs and risk.
This article will focus on the services development agreement and following below are some key considerations for such an agreement.
A services development agreement is commonly used to meet these objectives with each tailored to the parties’ needs and type of development.
Structuring, duties and taxes
As the transfer of real property (land) triggers potential stamp duty, capital gains and other taxation implications the arrangement should be structured to minimise or avoid unnecessary liability.
To avoid duty, the agreement must be drafted to ensure there is no transfer of land from the owner to the developer. In some states, duty is charged on a change of ownership in land deemed by the creation of a constructive or resulting trust. A trust situation could be inadvertently construed by the terms of the agreement resulting in an unexpected stamp duty liability. Accordingly, the provisions should clearly specify that the parties are at arms-length, the developer has been retained (only) to carry out the services specified, and the land is held by the landowner until sold to the ultimate purchaser.
The treatment of any Goods and Services Tax (GST) under the agreement should be set out clearly and appropriate advice sought from a financial professional.
Project administration / allocation of costs
The agreement should set out the fundamental scope and purpose of the project – how the development will be managed, staged and funded, and the respective parties’ rights and entitlements secured. Provisions should specify which party is responsible for what costs and how net proceeds from the development will be realised, whether through a development fee, a profit-sharing basis, or other method.
The parties will need to consider the design and quality of the proposed development, its costs, potential gross revenue and net return. The agreement should deal with unforeseen cost increases, set minimum standards for the development and include provisions to approve any variations to the design concept.
Each party will want some control and input over consultants’ and project managers’ fees, design, development and construction costs, financing costs and unit / sale prices. These figures can be set out in a project budget attached to the agreement including a proposed list price for the sale of each unit / apartment.
The timing of the project, together with milestones (development approval, finance approval, commencement and completion) should be considered and the inclusion of a sunset date allowing either party to terminate the agreement if the relevant milestone is not met by that time.
Allocation of risk
Risks such as planning, construction, occupational health and safety, quality and defects will be allocated and shared, where relevant, between the landowner and developer.
The agreement should set out what happens if the development is not approved by the planning authority, for example whether the parties will appeal the decision, concede to a lesser development (and if so, the minimum acceptable development) or terminate the agreement.
Construction-related risks, such as development delays, material and labour cost increases, unanticipated site costs, adjoining owners’ protection works, legislative changes and industrial relations issues should be allocated throughout the agreement.
Quality and defects risks will generally be dealt with by the developer requiring the contractor engaged to undertake the building work to provide contractual warranties directly to the landowner.
The occupational health and safety risks must be assessed in accordance with State legislation to ensure adequate insurance and systems are in place and that neither party is exposed to unacceptable risk.
Termination, deadlocks and dispute resolution
A development will typically run over several years and the agreement needs to reflect this by including dispute resolution clauses to avoid deadlocks, and so the project is not excessively delayed and can reach its full potential. Provisions should also contemplate and account for unforeseen circumstances such as the death or insolvency of a party.
Various arrangements may be utilised when developing property and choosing the most appropriate structure for your needs and type of development can impact significantly on the success and profit of your project. The issues identified above are just some of the matters that should be considered.
Given the substantial capital involved and equity at stake, it is important for parties contemplating a land development to obtain independent legal and financial advice.
If you or someone you know wants more information or needs help or advice, call us on 61 2 9212 1099 or email us firstname.lastname@example.org for more information.