New Zealand: Buying a property to be built…watch for the pitfalls!

Last Updated: 30 July 2017
Article by Tim Stevens

Following on from a previous article that examined issues that arise in commercial property transactions, this article is the second of a series that examine various case studies of problems that arise, how they can be avoided and what, if anything, can be done to avoid these pitfalls. In this article we look at turnkey commercial buildings.

Scenario 1 – Walt is buying a commercial property from Jessie. The agreement is for a commercial property that is in the process of being built. The building costs blow out and Jessie is unable to complete the final stages of the building. What can Walt do?

There is an element of unavoidable risk in purchasing a property yet to be completed and Walt needs to understand that, however there are steps that can be taken to mitigate against the worst outcomes. Two common ways to protect Walt are discussed below.

The first, and most common is to include a sunset date by which the building must be complete and if not, then Walt can cancel the contract with the return of his deposit. To allow this the contact would need to state that the deposit is not released to Jessie until he is ready to settle. This mechanism prevents Walt from being locked into a contact to purchase the building indefinitely while Jessie tries to sort out his finances. While it is better than the worst case scenario (being stuck in the contract indefinitely with a vendor who is unable to complete the building) Walt may have missed out on a good commercial opportunity if the contract was at an attractive price.

A second way to mitigate the risk of Jessie not completing the building is to include a mechanism in the contract whereby Walt can bring settlement forward at a price reduced by the price of the works yet to be complete. This mechanism is normally triggered in the event the works are not complete by a set date. In our example, Walt would serve a notice on Jessie advising a settlement date, there would be a mechanism to calculate the price reduction and settlement would then take place at the reduced rate. This solution gives Walt the control over completion and also provides a good incentive for Jessie to complete the construction. A complication for Walt is that he may be settling without a code of compliance certificate and would need to obtain his insurer's and financier's approval. Further, if Jessie can't pay contractors then he may struggle to pay back any lending and discharge a mortgage if there is one registered against the property.

Careful legal drafting and caution is needed at the outset if either of these options are to be included in the contract.

It is also worth emphasising that both of the mechanisms discussed above are used in worst case scenario outcomes where the vendor cannot finish the build. The best way to mitigate risk is to do your due diligence on the vendor. Understand what projects they have worked on before, how they have turned out and what their reputation in the market is.

Scenario 2 – Walt is buying a commercial property from Jessie. The agreement is for a commercial property that is in the process of being built. Settlement is to take place after the code of compliance certificate issues. The code of compliance certificate issues and settlement takes place, but there are still significant works that need to take place. What can Walt do?

Issue of a code of compliance certificate confirms that the council is satisfied that the building work undertaken complies with the approved building consent. It does not mean that the work has been completed to the contractual standard Walt expects. Walt's solicitor needs to include in the contract wording that provides settlement is the later of the code of compliance certificate issuing or practical completion taking place. Practical completion is a term that would be need to be defined in each instance it is used, but here it could mean, being completion of the building to a reasonable standard certified by an independent party. Further, wording in the contract should be included where Walt can settle with only the code of compliance certificate if he chooses and on that basis gets to retain a certain amount in his solicitors trust account until practical completion has taken place. This gives Walt the ability to recover his funds in the event Jessie cannot complete what he needs to. Again, careful drafting and thought needs to be given to this as the retention amount needs to be large enough to incentivise Jessie to complete the works and cover any costs Walt incurs in the event that he does not complete it.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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