Fixed price contracts and unknown development costs

Fixed price contracts and unknown development costs

Published:

Author: Gavin Le Chat

Having to agree a fixed price for land in a contract when there are a number of unknown factors that affect value is a challenge for developers

This is a common issue when developers negotiate a contract conditional on obtaining planning permission for a development.

Contractual provisions can provide a solution if a seller will agree to the principle of a price reduction should certain assumptions turn out to be incorrect. The developer must also ensure he considers the impact of the new Community Infrastructure Levy (CIL).

In calculating the purchase price he is prepared to pay, the developer will usually make various assumptions in relation to some or all of the following:

  • the Section 106 costs payable pursuant to any planning obligations associated with the planning permission
  • abnormal development costs, some examples being the cost of carrying out ground treatment works (including site remediation works), the cost of diverting existing services within the property, and the cost of bringing services to the boundary of the property and making connections to the public sewer and water mains networks
  • the number of dwellings authorised by the planning permission and the floor area of such dwellings
  • the number of affordable housing dwellings which the planning permission or planning agreement will require to be constructed and the tenure mix and the size of such dwellings

If any assumptions should prove to be incorrect, the economic viability of the project could be seriously prejudiced, with potentially disastrous consequences for the developer.

The contract should therefore give the developer an absolute discretion to decide whether or not a planning permission is satisfactory and the ability to terminate the contract if he considers any planning permission granted to be unsatisfactory.

Whilst having an ability to terminate the contract is clearly desirable, it is not entirely satisfactory. The developer is likely to have spent considerable time in applying for and obtaining a planning permission.

It would be far better, from the developer's point of view, for the contract to provide for:

  • the purchase price to be reduced by the amount by which any assumed section 106 costs and any assumed abnormal costs exceed the actual section 106 costs and the actual abnormal costs
  • the purchase price to be adjusted where any assumptions made in relation to floor area and/or affordable housing prove to be incorrect

Having agreed a price upfront, a seller may be opposed to the concept of a price reduction unless the deductable costs are subject to a cap.

However, this may leave the developer feeling exposed and the parties may need to compromise and agree that if the deductable costs exceed the cap then, unless the developer or the seller is prepared to meet the excess, either party will be entitled to terminate the contract.

Another factor which a developer will need to consider when calculating the price for a site is whether the local authority has decided to implement CIL. If so, on a development of new housing CIL will be charged in pounds per square metre on the gross internal floor space of the dwellings, and will be payable on commencement of development.

The contract should be made conditional, not only upon the grant of a satisfactory planning permission, but also upon any requirement to pay CIL not having a detrimental effect on the economic viability of the project or requiring a payment in excess of a specified figure.