COMMENT | First come, first served in developer insolvency

Northern cities have enjoyed such a sustained period of growth that it is hard to imagine the boom coming to an end. However, despite the prevailing optimism, there have been casualties among developers and investors, writes Alastair Lomax of TLT and Steve Williams of FRP Advisory.

The circumstances have shed light on how developments are funded in the current economic climate and what happens to investors when things go wrong. The prominence of overseas and less-experienced, private investors is a recurrent theme.

In July, administrators from FRP Advisory, assisted by the banking and restructuring team at law firm TLT, concluded the sale of a part-complete development known as Birchen House, a mixed-use property close to the waterfront in Birkenhead. The sale marked a major milestone in the administration of the developer, Birchen House Limited, who had attracted substantial investor interest.

The case has been closely watched by the North West property market. The sale was made possible as a result of a court ruling in April, which tested legal principles that could affect anyone invested in similar developments in future.

Sadly, despite the administrators’ best efforts, only a handful of the developer’s creditors have thus far recovered any of their money. The court hearing that authorised the sale examined the complex legal rules governing the competing claims of lenders and investors. The judge’s decision confirmed who the administrators must pay from the sale proceeds and who would be out of pocket. The court was presented with secured creditor claims from over 50 private investors who had paid substantial deposits to purchase apartments at the development “off-plan” as well a substantial claim from the bridging funder who had taken a mortgage over the developer and the site itself.

Many of the investors were private individuals with limited property investment experience and many were based outside the North West; across the UK and overseas. Their deposits – paid on an agency basis – had been fully spent on the development works by the time of the administrators’ appointment. The judge praised the efforts taken by the administrators and their advisers to protect the interests of these investors – many of whom now face the daunting prospect of trying to recoup their losses through litigation against other parties.

Ultimately, the judge backed the administrators’ plan to sell the site free of all security so as to generate the best price. He also supported the administrators’ view that the order in which creditors must be paid from the sale proceeds depended on whether and when each creditor’s interest was formally registered at the Land Registry. Those who had not formally registered their interest – including many who invested early on in the project – ranked behind those who had. In this case, regrettably, that meant that they would recover nothing. In fact, so great was the disparity between the site sale value and the level of creditor claims that even many of those who had registered their interests would be left with no money back from the sale.

The funding structure was similar to many schemes that now dot the skylines of Manchester and Liverpool; schemes often supported by investors who are backing the market to generate returns that are no longer available further afield. Many have little or no prior knowledge of the local property market, let alone of the development itself.

The outcome of this case might appear harsh but a strict “first-in-line” legal principle applies to the registration of interests in property. For lenders and investors, this case underscores the importance of getting good advice early and using due diligence to gain a clear understanding of the risks before committing funds, and ensuring their advisers have adequately protected their legal interest and established priority against other investors.

Alastair Lomax is a partner at UK law firm TLT, while Steve Williams is a partner and licensed insolvency practitioner at FRP Advisory