Development management agreements in brief

Posted: 07/02/2022

Development management agreements are a means of bringing together the expertise of development managers, who are often developers or former developers, and the financial resources of funds and others who wish to bring forward a site.

These agreements – whose origins can be traced back to the property crash of the early 1990s and the subsequent demise of the merchant developer model – differ from the more traditional forms of development agreements, in that the development manager assumes the role of a lead consultant, and the employer provides the financing and engages the professional team and the construction team.

The arrangement is mutually beneficial in that it allows investors to gain exposure to the upside of direct development, without the need to establish a team and carry all of the associated risk, while enabling development managers to leverage their expertise to take on larger projects without raising capital or assuming substantial project risk.

That is not to say that engaging a development manager should be treated in a similar fashion to other consultant appointments, since the development manager will inevitably be a critical factor in the success or otherwise of a project, and will normally be incentivised in a manner that is commensurate with the scale, complexity and value of the project.

This article touches upon some of the main points which employers, who will usually own the site, and development managers should think about when entering into discussions with one another, though it is by no means exhaustive and legal advice should always be sought.

What to expect?

The forms of agreement are predictably more bespoke than the building contracts and appointments with which readers may be more familiar, but most agreements will share certain features. 

While those include a number of relatively standard provisions that are either uncontroversial, or best left to lawyers to finesse, there remain a wide range of issues that will be for the parties to consider and take commercial positions on, such as:  

• The scope of the development manager’s services.
• The basic fees and payment profile.
• The performance fee (also known as a promote).
• The rights of suspension and termination.
• The development manager’s authority and the restrictions on it.
• The employer’s duties and discretion.
• The duration of the agreement.
• The ability to sub-contract and to assign or novate the agreement.
• The limits on, and duration of, the development manager’s liability.

This article will not attempt to explore all of the above here, but the first four – which are arguably the most important – are touched on in more detail below.

The big four

Scope of the development manager’s services

The scope of the services to be provided by the development manager will tend to be quite wide and may encompass any of the following, in addition to the core role of managing the build, namely: producing or inputting into a business plan; co-ordinating the planning and vacant possession strategies; and overseeing the appointment of the professional team and the construction team. 

It may also extend to advising in relation to the letting and/or disposal strategy, and the provision of asset management and company support services, though these may attract further fees that are either agreed in advance or as and when the need arises.

However, the precise services will be specific in each case and will depend upon the nature of the project and the stage at which the development manager becomes involved. The intended procurement route and the make-up of the construction team will also have a bearing upon the services and the cost of performing them.

For example, a complex project for which planning permission has not been obtained, and which is expected to be procured in phases under separate building contracts, is quite a different proposition to a project for which there is a consented scheme, and it is anticipated  works will be carried out under a single fixed price design and build contract.

Basic fees and payment profile

There are many ways in which the development manager’s remuneration for its day-to-day work may be determined and paid. 

It may be via a fixed fee paid on a straight-line basis during a specified period, or apportioned in respect of distinct phases or milestones. It could also be a proportion of the professional fees and build costs that is paid as and when they fall due. Both of those approaches will have their advantages and disadvantages, much like any of the numerous other methods which may be adopted. 

To take the former example, a fixed fee payable in line with an agreed profile might be desirable for certainty, but would not move in step with changes to the project or the programme. It could therefore lead to dissatisfaction or disengagement in circumstances where the development manager’s fees prove inadequate or overgenerous, or end up being accelerated or delayed when measured against the programme on which the fee profile is based. On the other hand, a fee that is paid in line with the professional fees and build costs may be out of kilter with the resources brought to bear by the development manager at each stage of the project and, from the employer’s perspective, may be felt to incentivise poor behaviour on the part of the development manager.

The basis of the fee and the possible payment profiles will therefore need to be carefully considered through the lens of the project and its anticipated milestones. Thought will also need to be given as to how changes to the project or those milestones will impact the fee and the payment profile.

Furthermore, the creeping impact of construction and tax law will need to be factored in, since the agreement will likely be subject to the scheme of payment notices and mandatory adjudication mechanisms etc that are applied to a ‘construction contract’, and may also fall within the ambit of the Construction Industry Scheme and/or the reverse charge to VAT. It is therefore sensible to include contractual provisions addressing these so as to avoid causing any confusion further down the line.

Performance fee

The use of performance fees in these arrangements is fairly conventional, and reflects the central role which the development manager has in delivering the project and contributing towards its success, whether in terms of maximising the available space, minimising the costs or maintaining programme in the face of the unexpected.

A common measure of success is in terms of the employer’s profit, which can be established by deducting the costs of the development from the resulting capital value of the completed development. The development manager is then awarded a performance fee calculated by reference to one or more hurdles over and above a certain level of profitability. The calculation is usually carried out on an internal rate of return basis, though other bases of calculation may be adopted.

Alternative, or additional, incentive arrangements might include the payment of a specified fee for securing a particular planning permission or achieving practical completion ahead of programme, or they may involve the sharing of any cost savings achieved by the development manager.

The precise mechanics of the performance fee will need to be agreed on a case-by-case basis, and there will be considerable scope for negotiation as to when the fee will be calculated and paid, and what will be taken account of in order to arrive at a profits-based fee.

Suspension and termination

The need to accommodate the unexpected is seen, in particular, through the suspension and termination rights that will regularly appear in these agreements and almost inevitably generate a certain level of contention.

The employer will naturally wish to retain the discretion to sell the site and to postpone or abandon the project, either at its discretion or in particular situations such as the refusal of planning permission. The development manager, on the other hand, will be keen to ensure that its income stream is maintained and that its entitlement to a performance fee is not forfeited.

While reconciling these conflicting drivers can be difficult, various potential compromise positions exist and may provide a mutually acceptable landing point. For example:

• The development manager may agree that the employer should have discretion to postpone the project, but only in the case of a force majeure event and/or only for up to a specified maximum period, during which time the employer will pay either a reduced fee, or the development manager’s costs of holding together its team.
• The development manager may also accept that the employer should be entitled to terminate in certain circumstances – which may be following the expiry of a long stop date or upon a sale or a change of control – but on the understanding that it will be paid a break fee on early termination and will retain its entitlement to the performance fee, or a proportion of it, depending upon the stage the project has reached at the time of termination.

The manner in which these questions are dealt with may well set the tone for the wider negotiations.

Summary

Would-be employers and development managers should approach any discussions and subsequent negotiations in the knowledge that they will be embarking upon a relationship which, all being well, will likely span a number of years and necessitate close collaboration and good faith.

It is hoped that this article will serve as a useful overview of some of the key commercial terms that they will need to consider in navigating what is, after all, merely the beginning of a journey.

Greg Phillips is a senior associate solicitor specialising in real estate development at Penningtons Manches Cooper.

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