Development Finance

Ring-Fencing And The Importance Of Special Purpose Vehicles

28th May 2024 | James Meehan


A common question we are asked when structuring a development loan for a client is “What should the borrowing entity be?”. This is an important part of loan structuring, especially if a client has multiple projects or assets in various stages of the development cycle.

When a development financier looks to fund a project, they will “ringfence” the security.

When we refer to ringfencing, this means that the lender will focus on the security they will take specific to the project in question. This includes the land and improvements on site, the consents, the relevant contracts (construction, civil, pre-sales etc.), the company that is borrowing the money and the key people or persons behind the borrowing entity.

Unlike a residential mortgage, there is usually no focus on debt servicing for a development loan, but rather on what the lender’s position looks like on completion acknowledging repayment is typically realised from sale of the completed stock. Because of this interest and fees will be capitalised for the term of the loan (see our other blogs on interest capitalisation if you’d like to brush up on this!).

This is why having an SPV as the borrowing entity is important.

What is an Special Purpose Vehicle (SPV)?

An SPV is a special-purpose vehicle set up to undertake a specific project or hold a specific asset. A special purpose vehicle is a subsidiary entity (usually a company) created by a parent company or individual for a specific purpose.

The SPV can be used to isolate financial risk (debt obligations), securitize assets, and perform separate financial transactions. It is usually a company entity with the directors and shareholders being those that are party to the project and loan.

A simple and common example we see in the development finance space is setting up an SPV entity named after the address of the project.

Why is it important to borrow under an SPV?

When you borrow money from a development lender, they will protect their position with a range of securities documented by their solicitors (loan documentation). The typical structure you can expect is a first (or second) mortgage, a first or second-ranking General Security Agreement (GSA), Specific Security Agreement(s) (SSA) and personal guarantee(s).

For this article, we are going to focus on the General Security Agreement, as this is what can typically cause issues for developers.

What is a General Security Agreement (GSA)

A GSA is a legal agreement that provides the lender with security over all the present and after-acquired assets of the company that is providing the GSA (outside of the land and buildings, which are covered under the mortgage).

Given an SPV is typically set up just before the project commencement, the SPV company will typically only have one asset which is the subject property and its subject consents. This limits the lender’s GSA to the subject property and doesn’t tie in any other assets the parent company may own now or in the future.

What can happen if I don’t use an SPV and have a shared GSA?

Similar to a mortgage, there is a ranking system for a GSA. A development lender will usually require a first-ranking GSA, however, there are instances where they may allow a second-ranking GSA when the borrower they are looking to fund has existing debt under the same entity with another lender. This increases both the lender and borrower’s risk.

The issue that can arise is that if there is an event of default on one of the loans, then it can trigger a default on the second loan (cross-default) with the second lender simply because of the shared General Security Agreement. This cross-default scenario would be avoided if a separate SPV entity was set up as the borrower for each individual project as the security would be ringfenced to borrow a phrase from earlier.

Events of default do happen from time to time. For the most part, it’s not due to misconduct by the borrower, but rather events outside of their control. Common examples we see are major cost overruns, contractor insolvencies, and breaches of the loan term (usually due to delays or changes in market conditions prohibiting a timely exit).

The majority of development finance lenders in New Zealand, be they banks or non-banks, understand that these issues arise from time to time, and the lender is typically accommodating providing the borrower keeps the lines of communication open.

Despite this, it is always advisable to segregate your borrowing with an SPV entity to avoid the domino effect if you have multiple projects.

Note that the personal guarantees given will tie in the sponsors other assets but can’t be used to trigger a cross-default on another project that a separate lender has a first-ranking mortgage and GSA over i.e. the second project can continue without issue to completion.

How do I create a brand if I need SPV’s?

This is a good question and often why developers will want to have a single entity complete many projects. In this instance what we recommend is that you have a parent entity that represents your brand. This entity would be the primary shareholder in any SPV and functionally be the ‘brand’ and developer delivering the project where the SPV is just the vehicle that carries the risk.

Many developers operate like this with parent companies that own multiple SPV’s for each project.

What are the common SPV’s used for property development

The most common structure for development entities is a limited liability company. These are simple to set up and can be closed easily once a project is complete. Other entities could be a limited partnership or business trust. These are less common but are used from time to time for property development.

It’s always advisable to seek out trusted legal advice so that your position is as protected as possible, and so that you have a thorough understanding of the legal documentation involved with a development finance facility.

At Lateral Partners, we work with a large range of trusted and competent solicitors and would be happy to make some recommendations to you.

Please reach out if you have any questions.

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