Construction contracts – what to look out for when purchasing a newly built commercial property
Our construction team explores the various constructions contracts involved in the erection of a new commercial building and what a purchaser should consider as part of its due diligence process.
There are usually lots of issues to consider when acquiring a new commercial property, construction being one of the most important – how can a purchaser be certain that the property is built to the required standard and that it is protected against any issues that may occur later down the line? A thorough due diligence of the property prior to completion will help to ensure that the purchaser is aware of any problem areas, but what questions should the purchaser ask during this process?
The parties involved
As starting point, the purchaser should enquire what parties have been involved in the construction of the property. Most commonly the owner of the property may start by instructing an architect and a civil and structural engineer during the pre-building phase. Once the necessary planning permissions have been granted and the parties are confident that the project can proceed, the owner may next appoint a contractor, who will be responsible for the construction of the building and a cost consultant, to help with the approval and managing of the building expenses.
If the project is being procured on a design and build basis (meaning that the contractor becomes responsible for the whole of the design and construction process), the appointments of the architect and engineer will usually be transferred from the owner to the contractor.
The contractor may appoint further professional consultants to assist with the build such as a mechanical and electrical engineer and various sub-contractors covering areas such as the steelwork, flooring and lifts.
The appointment of the professional consultants and contractor should be in writing. Most professional consultants are regulated by their own professional bodies and many may want to contract on the basis of the standard form documents published by the relevant professional body. An owner may prefer to use a bespoke form of appointment drafted by a legal adviser.
There are also various industry standard forms of building contracts that the owner can use to appoint a contractor, but the JCT suite of building contracts are used most commonly.
Assignment of the construction contracts
The purchaser of the property will not be a party to these construction contracts, but as the new owner the purchaser should have the benefit of these contracts. This can be done through an assignment of the construction contracts. The effect of an assignment is to transfer the rights under the contract to the purchaser, including the right to bring proceedings, whether in court, by arbitration or by adjudication.
A contract may be freely assignable, or it may completely prohibit assignments, or it may be assignable only with the other party’s consent. The purchaser should, as part of the due diligence process, review the construction documents to ensure that assignment of these contracts are possible and what limitations, if any, are included in the assignment clause.
An assignment should be made in writing and, once this has been done, notice of the assignment must be given to the counter-party to the contract – for example if an owner assigns a JCT building contract to a purchaser, notice of the assignment should be given to the building contractor.
Novation of the construction contracts
Sometimes it may be appropriate for the owner to novate, rather than assign, the construction contracts to the purchaser – for example where the works are still ongoing at the time the property is sold. The effect of a novation is to transfer the obligations (for example the obligation to make payments) under a contract as well as the rights. A contract will always need the consent of the other party before it can be novated (usually this will be done by making the other party a party to the deed of novation).
A purchaser of a new build commercial property should always undertake a thorough due diligence of the construction aspects to determine what parties were involved in the construction of the building, what construction contracts have been entered into, and whether these contracts can be assigned/novated from the owner to the purchaser. If the owner needs to retain the contracts for any reason, the purchaser will need to look at whether warranties or third party rights can be granted by the contractor and professional consultants instead.
Please contact Susan Wells or Cathrine Ripley in FSP’s construction team if we can help with any of the topics in this note.