Section 106 insights: Part 2

Early and late stage development viability reviews

Viability assessment is a means of determining whether a proposed development of a site is financially viable. It involves an assessment of whether the value to be generated by a proposed development will be more than the cost of developing it, giving the developer sufficient return on investment to justify the risk involved in development. Determining the viability of a scheme is by no means a straightforward process, but it is critical, since viability may influence the package of obligations to be secured by any s.106 obligation required in connection with the grant of planning permission. Where the initial financial viability appraisal (FVA) produced at the application stage shows that a scheme would not be viable if fully policy compliant, the local planning authority (LPA) may agree to waive or relax certain commitments prescribed by policy. Often this will not, however, be the end of the story. The LPA may insist that the final s.106 obligation includes provisions requiring ‘early stage’ and ‘late stage’ viability reappraisals, which may show that the proposed development is more viable than previously assessed and can therefore deliver more planning gain.

Early stage reviews in s.106 obligations are generally triggered on ‘substantial implementation’. This reflects a stage of development being reached, perhaps the casting of the first floor slab, within a period of time (e.g. 36 months from the grant of planning permission). If the development has not reached the required stage by the required date, then development viability will need to be reassessed. This generally focusses on whether the development can afford any more affordable housing, specifically whether: any of the market units can be converted to affordable units; or higher value affordable units (shared ownership) can be converted to a lower value social housing tenure.

When it comes to negotiating early stage review provisions, the key is for the developer to have contractor input on the build programme, which should be provided to the LPA. This way the parties are more likely to agree a realistic stage of construction and time period for triggering any early stage review. There is little value in the developer agreeing to a trigger that it knows it cannot beat, meaning an early stage review will be inevitable. The aim, of course, should be for construction to proceed as planned, so that an early stage review is avoided. If unforeseen circumstances delay construction, then the developer may be able to extend the 36 month date by relying on the force majeure events clause we discussed in Part 1 of this series.

Late stage reviews are generally triggered when a fixed percentage of market housing has been sold/occupied. The aim for the developer should be for the initial FVA approved at the application stage to be re-run, but this time using actual costs and revenue figures, rather than estimates. Some LPAs will seek to take a formula based approach, rather than a full re-run of the FVA, which often limits the late stage review to an assessment of construction costs only. This means stripping out all other cost classes, yet requiring all revenues (excluding affordable disposals) to be included. A formula based approach may achieve a fair result on smaller developments, but on more complicated builds and multi-phase projects, it is likely to have the effect of artificially suppressing costs, which means that the ‘surplus profit’ in the development is highly likely to be overstated. The only fair approach is to re-run the original FVA. Whilst it may take longer for this to be agreed than the application of a formula, it should lead to a more robust and accurate result. The LPA can of course reasonably insist that its own viability adviser reviews the new FVA at the developer’s cost.

Delays in agreeing the new FVA or agreeing the inputs into a formula should ideally be resolved by reference to a dispute resolution clause in the s.106 obligation. In this regard, the late stage review provisions should allow the developer to trigger dispute resolution after a fixed period. This is particularly important, because often s.106 obligations will provide that the outcome of the late stage review (usually the payment of an affordable housing contribution if there is ‘surplus profit’) must be paid before a fixed percentage of the market housing is occupied. The difference between the percentage that triggers the late stage review (say 70 per cent) and the percentage requiring payment of the contribution (say 85 per cent) may only be the difference of a handful of units on smaller schemes. Accordingly, providing the developer with the ability to have the FVA independently determined via dispute resolution is vital to ensuring that occupation of further market units is not prevented by delays whilst viability assessors wrangle over details.

Dealing with multiple parties

In cases where the developer owns the land to be developed, the number of parties to any s.106 obligation will be reasonably limited and defined. The parties will usually be the developer, the LPA, the developer’s mortgagee and, where relevant, the county council. If the developer and the landowner are not one and the same, then the landowner(s) will need to be included as parties. The rub comes when parties are introduced that only have a minority interest in the development site, but are perhaps hostile to the development or generally uncooperative. Problems may also arise when certain bodies request inclusion as a party, and there is a risk that the body seeks to use its involvement as leverage for some unrelated matter or to increase the number of planning obligations that favour them.

• Where a hostile or uncooperative party owns an interest in the site, but the developer is due to acquire it, then it should be possible to agree with the LPA that, instead of the landowner being a party, the s.106 obligation includes provisions requiring the developer to bind that later acquired interest to the s.106 obligation. This could be achieved by entering into a confirmatory deed once the third party interest has been secured, a draft of which may be attached to the s.106 obligation.
• Where a body seeks to use the fact it is a party to the s.106 obligation as leverage, but their only function is to receive one or more financial contributions, then it should be possible to agree with the LPA that the LPA itself acts as a post box for the funds and simply passes these on once paid. Alternatively, the developer could covenant to pay the funds to the body directly and provide proof of payment to the LPA. In these scenarios, however, there will be no contractual guarantee that the body will use the contributions for their intended purposes. There also will not be any repayment provisions, should the body fail to spend the contributions within a prescribed period. In some cases, however, bypassing the need to include the body as a party to the s.106 obligation may be the lesser of two evils.

Delay is generally the enemy of developers and having too many parties to a s.106 obligation can significantly impact the negotiation process, as it will inevitably take longer to achieve a settled draft. If multiple parties are unavoidable, all party page turn meetings (with lawyers and clients in attendance) will generally speed up the process. Plus, from experience, organising this type of meeting with a half decent working lunch thrown in tends to lead to higher attendance and better engagement at comparatively little cost to the developer client.

Deeds of variation associated with s.73 applications

Some LPAs continue to resist including clauses in s.106 obligations that provide that the deed will automatically bind subsequent s.73 permissions relating to the same scheme. Ideally such clauses should be included, as otherwise the parties will need to enter into a deed of variation or supplemental deed each time a s.73 application is recommended for approval.

Some LPAs will insist that the variation/supplemental deed required in connection with a s.73 application is a carbon copy of the original deed, save for obligations already discharged. Other LPAs will be content for the new deed to simply note the changes to be made to the original deed. Where multiple variations/supplemental deeds are entered into, and to avoid purchasers/lenders from having to track through the amendments, it is often a good idea to prepare a conformed copy of the s.106 obligation (i.e. with all the variations included) for your records, and make it available in a deal room, and perhaps attach it as a schedule to the last variation/supplemental deed.

Difficulties can arise where a scheme has been implemented and a s.73 permission is sought part way through construction. By this stage a developer may well be in committed construction and supplier contracts, as well as having fixed room sizes and layouts. For these reasons, attempts by LPAs to require developers to sign up to any new “standard’ construction employment obligations, or carbon reduction measures, should be strongly resisted. The same goes for new obligations requiring compliance with the latest guidance on space standards. Depending on the stage of development, it may be impossible for the developer to comply with such proposals, due to existing contractual commitments and design fixes. Equally, attempts to include additional financial obligations may need to be resisted, unless the FVA has been re-run and its shows that the viability of the scheme will not be adversely impacted.

Other parts of the series

See Part 1 of this series. Also look out for Part 3 of this series of s.106 obligation insights. If you have any questions arising from this article, or would like to discuss your s.106 requirements, please contact Sarah Fitzpatrick, Head of Planning on sarah.fitzpatrick@nortonrosefulbright.com or +44 207 444 3678.