Drafting a Development Agreement that works

This paper considers some of the key issues involved in drafting, negotiating and implementing development agreements, and assesses some of the ways to navigate through those issues. The paper also highlights some tips, tricks and common traps when dealing with development agreements.

What is a development agreement?

Development can be defined as the use of land; the subdivision of land; the erection or demolition of a building; the carrying out of works on the land; the use of land or of a building or works on land1. Development agreements are used to govern developments from simple small scale residential subdivisions through to projects as large and complex as the delivery of the Barangaroo precinct.

The term ‘development agreement’ is used to describe several types of agreement. It is a generic term used to describe an agreement between a land owning entity and a development entity which governs the development of a parcel of land. Unlike construction contracts, leases and contracts of sale, there are no standard development agreements. For example, Standards Australia does not publish an Australian Standard development agreement.

The term ‘development agreement’ is often used to describe the following types of arrangements:

  • Sale by a landowner to a developer with the landowner maintaining control over what is developed (Sale DA). This can occur with or without a profit sharing component. An example of this arrangement is the model used by government landowners such as Places Victoria in relation to Docklands in Melbourne;
  • a joint venture between the landowner and the developer (JV DA). Although the term joint venture also has a variety of meanings commercially and at law, the defining characteristics of a joint venture are:
    • it is formed for a single project and not as an ongoing business;
    • the product of the joint venture is sold separately and not in common by the parties;
    • the participants take shares of the product and do not share profits; and
    • the ownership of assets is retained separately by the contributing participants;
  • an agreement for services (Services DA) whereby:
    • the landowner retains the land until it is sold to the ultimate purchaser;
    • the developer is engaged by the landowner to develop the land;
    • the developer assumes the development risk;
    • the developer handles all marketing and receives the sale proceeds as the agent of the landowner; and
    • the developer accounts to the landowner in relation to the net proceeds.

Commercial Drivers

Development agreements are commercially driven. Each aspect of a development agreement is open to be negotiated between the parties.  The contents of the agreement and the type of agreement adopted will depend on the negotiating power of the parties and their respective commercial drivers.

The developer’s commercial drivers will likely include:

  • minimising the upfront costs and therefore minimising initial funding
  • sharing the development risk with the landowner
  • reducing the chance of assuming environmental liability and other land based liability and
  • minimising duty and other taxes and timing those liabilities to coincide with the receipt of income.

The landowner’s commercial drivers will likely include:

  • maximising the return on the sale of the land
  • sharing in the development profit
  • carrying little to no development risk and
  • carrying little funding risk.

The drivers for a government landowner may be different and, depending on the particular government entity, the drivers may include a greater focus on:

  • certainty of return on the development, both in relation to the built form and the financial outcomes
  • carrying no development risk at all
  • providing a positive outcome for the surrounding or adjacent areas.

A government entity will sometimes sacrifice some profit in order to decrease the risk and increase the certainty of the development.

The most common form of development agreement and the form which meets most of the key drivers of the landowner and developer is the Services DA. Government landowners commonly use a Sale DA with provisions aimed at ensuring the developer constructs exactly what the developer promised in an expression of interest or tender documentation.

In this paper, we primarily deal with Services DA and Sale DA.

A common thread running through the agreements is that the landowner will maintain some control over what is developed. The level of control is variable in each agreement, with the landowner maintaining a higher level of control in relation to a Sale DA and a lesser level of control in a Services DA.

Structuring

Often the parties will have received tax and accounting structuring advice prior to the commencement of preparation of the development agreement. It is important to understand the effects of the advice and ensure the agreement reflects the agreed structure and contains provisions consistent with the commercial aims of the parties.

The points to consider and safeguard against are different for each type of development agreement. However, any type of transfer of the land is important because it will have duty and tax consequences for both parties and may affect the feasibility of the development.

In relation to a Sale DA, the parties should ensure the sale price and any other monies payable under the agreement are structured correctly to avoid unnecessary duty and tax consequences.

Based on the reasoning of the High Court in the Lend Lease matter (discussed below), amounts payable under a development agreement to facilitate stage release under a contract of sale may be dutiable as part of the consideration for the land transfer.

In Commissioner of State Revenue v Lend Lease Development Pty Ltd2 the High Court found that duty could be charged on a transfer of land by reference not only to payments made under land sale contracts, but also to payments made under a development agreement, which together with the land sale contracts formed a single, integrated transaction for the sale and development of the area.

Lend Lease entered into a Sale DA with VicUrban in 2001 for the sale and development of part of the Docklands precinct in Melbourne. The parties agreed that the development would be staged and that VicUrban would transfer the land to Lend Lease in tranchesLend Lease would take a parcel of land, design, construct and sell residential and commercial buildings on the land. Each of Lend Lease and VicUrban would construct various infrastructure on and around the land.

Lend Lease was required to pay a stage release fee under the land sale contract, but was also required to pay additional amounts under the development agreement, including payments for infrastructure, a contribution towards public art, a payment for remediation of areas on and around the land and a share of gross proceeds received. 

The Commissioner of State Revenue assessed duty on the transfer of land under the Duties Act 2000 (Vic) as the total of the sums payable by Lend Lease to VicUrban under the development agreement. Lend Lease objected to the assessment and claimed that the consideration for the transfer should only be the amount specified in the land sale contract. Lend Lease’s submission was that sums that could be said to be paid as Lend Lease’s contribution to the cost of development work which VicUrban had done or would do, and sums that were to be paid as a share of amounts Lend Lease would realise on its sale of the Land, did not form a part of the consideration for the transfer3.

The Commissioner succeeded at first instance and the Court of Appeal found in favour of Lend Lease. The Court of Appeal stated that the judge at first instance incorrectly shifted his focus from the nature of the dutiable property transferred to the land as developed.

The High Court held that the consideration which moved the transfer by VicUrban to Lend Lease of each portion of the land was the performance, by Lend Lease, of the several promises recorded in the 2001 Sale DA (or that agreement as later varied and supplemented), in consequence of which VicUrban would receive the total of the several amounts set out in the applicable agreement. It was only in return for the performance of not only the obligation to make the “contribution” fixed as the stage land payment but also the obligations to make all the other forms of “contribution” that VicUrban was willing to transfer the land to Lend Lease4.

It is common for government landowners to structure development agreements in the same manner as the Lend Lease development agreement discussed above. The Lend Lease decision is particularly relevant for those developers who enter into arrangements under which the purchaser of land has additional obligations to the vendor in terms of infrastructure contributions, sharing of revenue from the sale of the developed land or other similar obligations.

The structural issues to avoid in relation to a Services DA are different. Provided a Services DA is clearly drafted as a contract for the developer’s services, then there should be no trigger for duty or tax implications before the sale of the finished lots.

For a Services DA, care needs to be taken to ensure:

  • there is no transfer of the land to the developer
  • a trust is not created over the land and
  • the distribution of proceeds does not trigger a land rich duty or landholder event.

It is prudent practice to include in each Services DA a disclaimer making it clear:

  • the landowner engages the developer to provide development services as set out within the agreement
  • the engagement of the developer is not intended to create a joint venture or a partnership and that the parties will be at arms-length and
  • the land will be owned by the landowner at all times until it is sold to a third party purchaser.

Note however that a mere statement by the parties as to the relationship will not of itself define the relationship5.

Avoiding creating a trust over the land

In some states, duty is payable on a change in ownership of dutiable property, including the creation of any beneficial interest in property, or the creation of a trust. It is, therefore, important to avoid creating a trust over the land which is the subject of the development agreement.

There are two relevant types of trust for the purposes of a development agreement: a resulting trust and a constructive trust.

A resulting trust is created by law when property is transferred to someone who pays nothing for it and who is implied to hold the property for the benefit of another6. Such a transfer gives rise to an inference that a person who transfers property to another person or purchases property for another person does not intend to benefit that other person.

A constructive trust is created immediately when circumstances exist in which equity would impose an obligation upon one party to hold property in its ownership for the benefit of another. It has been held that a constructive trust may arise even where the parties do not necessarily intend this to happen.

In 2002, Woodfield Constructions Pty Ltd (Woodfield) entered into a “Management Agreement” with Jojill Nominees Pty Ltd (Jojill). Jojill was the registered proprietor of a property and engaged Woodfield to manage a townhouse development project on the property. The development involved the construction of 3 townhouses with associated parking.

The agreement required Jojill to sell Lot 2 at Woodfield’s direction and not otherwise for the sake of realizing the proceeds. Woodfield lodged a caveat on the title to the property on 28 November 2002 claiming an “equitable estate in fee simple” pursuant to a “constructive trust arising from business dealings”.

The project completed and Lot 2 was transferred in accordance with Woodfield’s direction. After this occurred, Woodfield was issued a Notice of Assessment for duty payable on the basis that the terms of the Management Agreement evidenced a change in beneficial ownership in favour of Woodfield.

Woodfield argued:

(a)           that there was a contractual right to call for Jojill to sell the property and that did not constitute a proprietary or beneficial interest;

(b)           the agreement only provided Woodfield with a means to recover its management fees; and

(c)           there was no other basis for a change of ownership in relation to Lot 2.

The VCAT determined7:

(d)           the caveat was not and did not itself create a proprietary interest, however, it was indicative of Woodfield’s view of its rights in relation to the property;

(e)           a constructive trust was created in relation to Lot 2; and

(f)            the constructive trust arose regardless of the fact that the agreement did not gift the land to Woodfield, there was no express declaration of trust and no assignment.

The VCAT considered that a change in beneficial interest occurred once Woodfield had the ability to compel Jojill to transfer Lot 2 to a buyer selected by the Applicant and from which Woodfield would benefit. Woodfield’s application was dismissed and it was ordered to pay duty.

In order to avoid creating a constructive trust parties should ensure the development agreement does not give the developer the power to require transfer of a land to a particular party, with the benefit of the sale to the developer.

If the parties intend the developer to have a right to lodge a caveat over a property, it will be important in the development agreement to carefully define the right which will allow the caveat to be lodged. It might be better for the parties to utilise other security to safeguard the developer’s entitlements.

Input and output controls

The success or otherwise of a development and the profit realised by the parties turns in large part on the risk allocation within the agreement and the control each party has over the costs and revenue of the development. The development agreement must allow each party some control over the costs and revenue of the development.

In a Standard DA for a residential development:

  • the costs will include:
    • the equity allowed to the landowner for allowing the development to be undertaken on the land (an amount which is usually broadly analogous to the value of the land)
    • the amount paid to consultants to prepare the design, the construction costs, holding costs and other development costs
    • the amount paid to the project manager (which is often a related entity to the developer)
    • finance costs and
    • taxes
  • the revenue will depend on:
    • the design, including the quality of the product and the number of apartments or residences constructed and
    • the sale price of each apartment or residence.

The equity and the amount paid to the project manager are ordinarily negotiated prior to execution of the development agreement and included within the agreement. If the project manager is a related entity to the developer, it is customary for payments to commence once construction starts and to be funded out of the project’s finance.

In relation to the other costs, the developer ordinarily funds the development costs until finance has been obtained.

The development costs are usually controlled by way of a project budget. An initial budget is attached to the development agreement and an approval process included to deal with any unexpected increases in cost. In some instances, the developer will negotiate broader control so that the landowner may only object to an increase in the project costs if the projected costs increase the budget by a specific figure, e.g. 10%. Otherwise, the developer may proceed with the development as long as the costs are incurred in accordance with the budget.

The development agreement should also contain an approval process for the design of the development. The initial concept should be attached to the agreement and specific approval should be sought from the landowner for departures from the concept design. In the absence of a concept design, it is worth considering whether to include minimum requirements as to the number of apartments or commercial buildings and a benchmark as to quality.

The sale price of each apartment will generally be market driven and will be dependent on the size and quality of the apartments.

In a large scale development, developers prefer to be able to sell apartments on behalf of the landowner with little interference from landowners. It is common for the parties to negotiate a provision allowing the developer to sell to arms-length third party purchasers at a price not less than the price noted on the sale price list. In order to control the sale process, the landowners usually require input into the sale price and a right to approve or reject any proposed change in the apartment price list.

In addition to controlling the costs and revenue, it is important for the parties to agree on the timing of the development and the milestones which should be met in order for the development to be successful. Common milestones include:

  • obtaining satisfactory planning approval
  • obtaining finance approval and
  • commencement of construction.

In some instances parties also include an overall sunset date, whereby if the development is not completed by the sunset date either party may terminate.

If the parties share control over a development it is worth including appropriate deadlock provisions to ensure the development is not stymied. The development agreement should be drafted to minimise the possibility of deadlock occurring. The content of the deadlock provisions is a matter for negotiation, although the parties should ensure they at least include some form of dispute resolution.

Risk Allocation

The risk allocation differs in each type of agreement. In a Sale DA the vast majority of the risk is allocated to the developer. In a Standard DA the risks are usually shared between the parties and the agreement will specifically allocate each risk.

The following are common risks dealt with in a Standard DA:

  • planning risk
  • construction risk
  • market risk
  • occupational health and safety and
  • general quality and defects on the constructed property.

Planning risk is the risk that the relevant planning authority does not approve the design in the form proposed. The planning authority may approve the development with unacceptable conditions, reject the development or require amendments to the development. It may be prudent for the parties to negotiate the circumstances under which they will appeal a planning authority’s decision and the extent to which they exercise appeal rights and include appropriate terms in the agreement. This should assist to prevent a deadlock scenario occurring.

The parties should consider including minimum planning requirements in the development agreement. The minimum planning requirements will set out the agreed minimum number of apartments or size of the commercial development. If the minimum planning requirements are not met, the parties may agree to appeal the planning authority’s decision or terminate the development agreement.

Construction risk primarily relates to the risk of an increase in cost or delays to the project during the construction phase. The various types of construction risk include:

  • documentation risk, which is the risk of discrepancies or errors in the documents which make up the construction contract
  • site risk, the risk of unexpected site conditions such as soil contamination, imported fill, rock or soft spots or contaminated groundwater each of which can dramatically increase the cost of a project
  • change in legislative requirements which requires a redesign or further work to be undertaken
  • dealing with adjoining owners, including where protection works may be necessary on another party’s land and
  • industrial relations.

In most cases, the developer will engage the construction contractor and seek to pass most, if not all, of the construction risks through to the construction contractor.

Market risk is the risk of an adverse change in market conditions between the time the agreement is executed and when the parties are in a position to commence selling apartments. The agreement should include a clause which sets out the parties approach to adverse market conditions and whether, in such circumstances, the agreement will be terminated or put on hold.

Occupational health and safety is a really important risk from a land owner’s perspective as in some jurisdictions the legislation contains non-delegable duties on the party which owns the land upon which a development is undertaken. The development agreement should contain a clause whereby the landowner authorises the developer to act as the landowner’s agent and appoint the construction contractor as the ‘principal contractor’ on the landowner’s behalf.

It is common to deal with quality and defect risk by requiring the developer to procure the construction contractor to enter into a separate owner’s warranty deed with the landowner. The owner’s warranty deed usually requires the construction contractor to provide all warranties under the construction contract directly to the landowner. This will allow the landowner to take direct contractual action against the construction contractor if there are defects in the property.

Security and finance – existing mortgage/encumbrances

In most developments, the developer will obtain construction finance to fund the construction of the development. The development agreement should specifically provide for all security which may be necessary and set out which party will be responsible for obtaining the security.

It is not uncommon for at least three parties to seek security in relation to a development agreement:

  • the construction financier will seek security for the funding it makes available to the developer, this security usually takes the form of:
    • a first-ranking mortgage over the land
    • if the landowner is a company, a general security agreement over the undertakings of the company and personal guarantees from the directors of the company
  • the developer will seek security for the development fee, which would usually take the form of a second ranking mortgage (or third ranking mortgage if there is mezzanine finance) and
  • the landowner will often seek performance security from the developer. The form of this security can vary from bank guarantees or insurance bonds through to a general security agreement over the developer.

It is important for the developer to understand the current finance, if any, on the land and whether the land is leased or has any other encumbrance which may affect the feasibility of the development.

The development agreement should include a warranty from the landowner as to the encumbrances and security currently on the land and, in the case of existing loans, the amounts secured by those loans. The developer will need to ensure:

  • there is sufficient equity in the land to support the construction finance and
  • any leases on the land can be terminated or otherwise brought to an end in a timely manner to allow the development to proceed.

From a landowner’s perspective, the development agreement should clearly:

  • set out which party is responsible for obtaining finance
  • provide for the release of relevant security as the construction finance is paid out and the development fee paid and
  • if the developer seeks to take a mortgage, require the developer to enter into a priority deed in the form requested by the financier.

In addition, the agreement should provide that no further encumbrance or mortgage of any kind can be lodged or registered over the land without the prior written consent of the other party.

Dispute resolution

As a development agreement can run for 5-10 years, the dispute resolution provisions need to be carefully considered and tailored to the parties. Care also needs to be taken to ensure the dispute resolution provisions capture all disputes under the development agreement.

Generally, a solution which fosters a continuing relationship between the parties should be preferred.

The development agreement could include provisions requiring steps such as:

  • an initial discussion meeting or mediation between the parties
  • expert determination, with a particular expert nominated, which is binding except in the case of a manifest error of law
  • expert determination, with a different expert nominated for each aspect of the development, for instance:
    • a valuer in relation to any dispute related to valuations or the price list for the sale of apartments
    • a quantity surveyor in relation to any dispute related to the project budget, construction costs or the costs incurred by the developer in undertaking the project or
    • a legal practitioner in relation to a question of legal interpretation; and
  • arbitration or litigation.

Regardless of which steps are chosen, it is worth setting out in some detail the procedure to be adopted. For instance, if the parties intend to use expert determination, the agreement should specify how an expert will be chosen, what process the expert should follow and who will bear the costs of the expert determination.

The parties should be required to continue to perform their obligations under the development agreement, to the extent possible, during the dispute process.

Conclusion

As development agreements are commercially driven, the key to drafting an effective development agreement is to ensure that it reflects the commercial imperatives of the parties, while not inadvertently triggering the application of laws and levies which jeopardise the project’s feasibility.

The development agreement should provide each party with some control over:

  • the design of the development and
  • the project budget and the price list of apartments or the commercial tenancies.

As the relationship governed by a development agreement may last 5 years or more, the agreement should be drafted to avoid deadlock if possible. The parties should discuss and consider possible deadlock issues, such as planning risk, and include mechanisms and options within the agreement so deadlock does not occur.

Finally, regardless of the contents of the development agreement and how well it is prepared, care should be taken to ensure the parties understand the agreement and their respective obligations. A good understanding of the agreement will assist to minimise disputes.


1For instance, see section 4 of the Environmental Planning and Assessment Act 1979 (NSW)
2[2014] HCA 51
3at paragraph 48
4at paragraph 60
5Sarich v FCT 28 ATC4646
6Calverley v Green (1984) 155 CLR 242
7Woodfield Constructions Pty Ltd v Commissioner of State Revenue [2005] VCAT 2518


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