The Lender series publications are a series of easy to read and practical 'how to' guides aimed at assisting lenders with typical issues encountered when providing finance.
The collapse of the Ralan Group provides a timely reminder of the protections and safeguards that financiers implement when funding residential development projects. This practical illustration of why these safeguards are important is particularly relevant now; at a time when 'non-traditional' participants in the residential construction financing market are differentiating themselves by, among other things, being more flexible than 'traditional' financiers in relation to pre-sale coverage requirements. This article provides a brief overview of what has happened at Ralan, the issues that have arisen for Ralan's purchasers and how purchasers and financiers should (and in most cases do) protect themselves against those issues.
The Ralan Group is a Sydney based developer and manager of residential and commercial property. It is currently developing the four-stage 'Ruby' development and the 673 unit 'Sapphire' tower, both on Queensland's Gold Coast, and the 318 unit 'The Orchard' in Sydney's Arncliffe. The group went into voluntary administration in late July 2019 owing around $500m to creditors including Westpac, Wingate and Balmain Corporation. Investigations by administrators, Grant Thornton, soon revealed that the group's creditors included purchasers of units in the unfinished projects who had released the deposits paid by them on those units to Ralan as unsecured loans.
Grant Thornton estimates that the amount owed to such purchasers is $277m. Those purchasers are unsecured creditors who will rank behind the Ralan Group's secured creditors on any realisation of assets on a liquidation. They may not ever receive the keys to the unit they have contracted to buy or receive their deposit (or loan) back.
It was initially reported that the majority of affected purchasers had entered into 'side agreements' with two Ralan subsidiaries under which their deposits were released in full or substantially in full as unsecured loans to Ralan. It has since emerged that, in some cases, the loan was actually part of the sale contract – including an acknowledgment that the purchaser had obtained legal and financial advice.
The largest reported loan is $3.8m. The loan terms offered included interest rates of between 15% and 20% per annum. Interest was paid monthly or was deducted from the purchase price at completion. It seems that loan proceeds from purchasers were being used to make interest payments due to other purchasers.
Why is this unusual?
The release of deposits by purchasers in the Ralan case is unusual for two reasons:
- it is illegal in Queensland and contrary to market practice (and sound legal advice) in New South Wales (where it will shortly be unlawful too); and
- we assume it would have been contrary to Ralan's financier's 'qualifying pre-sale criteria' under the relevant finance arrangements.
In general terms, deposits under contracts for sale of land should be held by a solicitor or real estate agent in their trust account for application in accordance with the contract.
In Queensland, the use of deposits is prescribed by law. The Property Occupations Act 2014 (Qld) provides that part payment (i.e. a deposit) received under a sale contract must be paid directly to the public trustee, a law practice trust account or a property agent trust account and that any provision of the contract or instrument related to that contract which provides otherwise is void. There is a limited exception for deductions which can be made to pay 'transaction expenses/fees' – but such expenses and fees are narrowly defined to relate to the performance of the sales agent's role and duties. There is corresponding legislation in Victoria.
In New South Wales, there is currently no legislation providing protection for deposit money. Market practice is to pay deposits into separate trust accounts to avoid the risk of purchasers losing their money if the developer goes into insolvency. There are warnings in relation to the use of deposits published by NSW Government Fair Trading and in the current standard Contract for Sale and Purchase of Land. It would be unusual for any conveyancing solicitor acting for a purchaser to not warn their client of the risks of the purchaser agreeing for the deposit to be released to the developer.
There is pending legislation in NSW, the Conveyancing Legislation Amendment Act 2018 (NSW), which will amend the Conveyancing Act 1919 (NSW) to provide that deposits paid in relation to off the plan sales must be held in trust or invested – effectively restricting deposits being released to the developer prior to completion. This legislation will not come into effect until proclamation, which is expected to occur later this year.
Against the background of the safeguards for purchasers provided by legislation and / or market practice, financiers' usual qualifying pre-sale criteria and due diligence processes also protect purchasers (and the financiers themselves of course). These criteria and processes typically require that, for an exchanged contract of sale to form part of the 'qualifying pool' against which a financier will lend:
- a non-refundable deposit of at least 10% of the purchase price be:
- paid in cash into the trust account of a solicitor or licensed real estate agent; or
- satisfied by way of unconditional bank guarantee or deposit bond on terms and from an issuer satisfactory to the financier; and
- in each case, that the cash, bank guarantee or deposit bond be subject to a deposit undertaking from the solicitor or real estate agent holding the deposit;
- the financier receives a pre-sale certification from the developer's solicitor, on terms satisfactory to the financier and sometimes supplemented by a sample review of contracts by the financier's solicitors:
- certifying that the exchanged contract is in the form of the 'pro forma contract of sale' (which will have been reviewed by the financier's solicitors and found to be acceptable / compliant with the financier's qualifying pre-sale criteria) or clearly setting out any differences between the exchanged contract and the pro forma so that the financier and its solicitors can consider whether the varied provisions are acceptable; and
- providing, if the solicitor holds any of the deposits, a 'deposit undertaking' in relation to those deposits as described below; and
- the financier receives a 'deposit undertaking' from each holder of the deposits confirming what deposits the deposit holder holds, in what form and in what amount, as well as an undertaking not to release the deposits otherwise than in accordance with the contract without first obtaining the financier's consent.
The deposits released to Ralan by purchasers as loans would not have satisfied these requirements. At this stage, the extent to which Ralan's financiers were aware of the apparently systemic release of deposits as loans is not clear. It may well be that they were not aware of them at all; perhaps because the applicable 'qualifying pre-sale criteria' did not cover the points referred to above or the solicitors providing the pre-sale certification were unaware of the side agreements documenting the deposit arrangements).
The Ralan insolvency is continuing to play out. As things stand, there is a significant risk that many of the affected purchasers will never own the unit they contracted to buy and will lose their deposit and any additional amount lent to Ralan. There is some hope for the purchasers in The Arncliffe where, following Wingate's acquisition of Westpac's senior debt, construction funding has begun to flow again and the builder has recommenced work; meaning that there is some prospect of those units being completed on time and delivered to the original purchasers on payment of the balance of the purchase price. Those purchasers are however unlikely to receive the 'upside' on any loan made by them to Ralan. There is also conjecture in the press around potential causes of actions against Ralan, the individuals behind it and even its financiers.
Key messages for financiers
The Ralan situation illustrates the importance of financiers insisting on stringent criteria in relation to the treatment of deposits and the legal due diligence and certification that they require to ensure that deposits are treated in accordance with that criteria.
Accordingly, financiers should treat any request from a developer to relax any of the protections and safeguards described in this article with caution. In addition, non traditional financiers who are able to offer more generous accommodation to developers in relation to pre-sale coverage should equally be alive to this issue; for example, even if the qualifying pre-sale requirement is less than 100% of the loan commitment, it would still be prudent to ensure that all of the pre-sale contracts deal with deposits in the same way as the qualifying pool, given that those 'non-qualifying' contracts still form part of the repayment source (and the security for) the total debt.
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.