The blame game: recent cases on valuer and project monitor liability (Part 2)
Part 1 of this blog post considered claims by lenders or investors against their engaged valuers. In this blog post we consider the funder's project monitor (PM). That is, the independent monitoring surveyor typically appointed by funders to advise on the risks of acquiring an interest in a development and thereafter monitoring the development and reporting to the funder, including providing approval for drawdowns.
In the words of Edwards-Stuart J in Lloyds Bank v McBains Cooper (see more below), the PM might be described as "the Bank’s eyes and ears in relation to the project". With that in mind, and as some in the industry may assume, is it right to say that a lender has an additional layer of protection insofar as it may sue the PM if they get it wrong, and recover its losses? Or, more bluntly, can your credit/risk teams really be comfortable knowing that the PM is certifying everything?
Cases that have had cause to consider the PM's role and particularly their liability towards funders are, unlike claims against valuers, comparatively rare. To some extent this may be because the losses that a bank might seek to recover from a PM would typically arise out of project cost "blowouts" (overruns) or delays. In the period before the global financial crisis (GFC) such losses were less prevalent as development values soared. However, in the aftermath of the GFC, three recent decisions in the well-regarded Technology and Construction Court (TCC) are worth exploring to examine any trends.
In Bank of Ireland v Faithful & Gould Ltd [2014] EWHC 2217 (TCC), the PM advised the bank on an ill-fated development project in Manchester including advising that £4.5m of materials were stored off-site, when no such materials existed. The bank sued the PM, which settled the claim but then itself pursued a claim against the valuer, alleging a negligent valuation that necessarily distorted the bank's perceived security position. The PM failed in that instance because it couldn't prove that the negligent valuation caused the loss to the bank (following SAAMCO, see previous post). It was held that the bank’s loss had instead been caused by the developer’s failure to complete the project, due to a lack of resources, and would have been sustained in any event.
However the judgment is interesting for these purposes because of the judicial comment on the duties of the PM, which does not form part of the court's decision. Although much of the analysis turned on the particular facts, and the terms of the appointment, it considered:
- Should the PM have advised the bank that the developer did not have appropriate experience or the resources to complete the development? No, the bank had made its own assessment of the developer and the project's feasibility and was aware of the developer's experience.
- Should the PM have highlighted there was no formal building contract and insufficient evidence as to ownership of materials in the event of the contractor's insolvency? No, the bank was aware of the contractual situation and was plainly being advised by solicitors who had not told them the arrangements were unsatisfactory.
- Finally, had the PM failed to investigate that drawdown requests were for justifiable amounts, properly incurred? Yes. This allegation went to the failure of the processes around "vesting certificates" and verifying the acquisition and location of and title to materials. In this regard the PM had failed to advise the bank, including the withering assessment that the PM "fell below the standard that could reasonably be expected from a competent project monitor".
The more straightforward circumstances of Lloyds Bank plc v McBains Cooper Consulting Ltd [2015] EWHC 2372 (TCC), in procedural terms at least, presented the TCC with another opportunity (actually, the first of two) to consider a PM's duties. Again the decision is based on the particular facts and it does not develop legal principles, however it represents a comprehensive treatment of what a PM should and shouldn't do.
It's worth noting at this juncture that in March 2015 (after Faithful & Gould but before McBains Cooper) the Royal Institution of Chartered Surveyors issued a guidance note (following a consultation), titled "Lender's independent monitoring surveyor". Designed to support the work of surveyors who assess risks and give technical advice to third-party finance providers, the guidance covers project structure, conflicts of interest, technical due diligence, financial close/contract completion, practical completion; and risk analysis.
In the present case, part of the bank's claim against the PM included the allegation that they were reckless in not visiting the site anywhere near often enough to comply with the requirements of their appointment regarding progress reports. The court disagreed, finding that 10 site visits for 17 progress reports did not make a case for recklessness.
There was significant confusion between the bank and its PM, including as to fundamental issues such as the amount of the facility, the deductions for interests and contingency amounts. This meant that the bank had fallen below the standard of a reasonably competent lender, and the PM was negligent not to have requested a copy of the facility letter.
The PM was negligent in confirming (in the first eight progress reports!) that the funding remained sufficient to complete the development, doing so in the mistaken belief that the borrower was providing part of the finance in the face of a self-evident shortfall (i.e. a contract value of £2.5m compared to the PM's understanding of a facility limit of £2.25m). The PM couldn't avoid the facts. It was in breach of its appointment and negligent, by admission.
Now, at the risk of labouring the point, we know that as with all claims for professional negligence, causation comes into play. The judge found that had the PM complied with the terms of its appointment it would have identified the issues (with the lack of funding headroom) earlier and the penny would have dropped for the bank, allowing it stop further funding and to mitigate its losses.
Unfortunately for the bank, the fact it was also held to be contributory negligent meant it had to swallow a third of the losses.
The second trial, on the same facts sought to resolve issues of quantum that were unresolved from the first. Lloyds Bank plc v McBains Cooper [2016] EWHC 2045 (TCC) looked more specifically at the duties of the PM in relation to the monthly drawdowns and the losses arising from its breach of those duties. The judge considered that these included exercising all reasonable skill and care when:
- Checking costs included in a drawdown request are justified and in line with the facility agreement.
- Reporting that relevant work (i.e. the subject of the funding request) had been carried out.
- Assessing a project's progress (particularly as regards delays or variations, which are crucial to a lender's risk analysis).
- Reviewing actual expenditure against cash flow to confirm that the borrower can meet the costs of achieving practical completion. Including considering in progress reports the likely cost of completing the project.
In perhaps the most pertinent observation on the drawdown process, the court stated that the role of the PM was not simply to provide information in its monthly progress reports. Rather it was "effectively advising [the funder] to pay the sum stated in the report". Ergo the PM is under a duty to protect the funder from paying sums that it shouldn't be paying and/or to flag up if or when the project goes awry. Such a report would enable a properly advised funder to review its position and take early action to mitigate its losses (i.e. drawstops, termination and/or enforcement).
In this case that meant the funder's loss was the money advanced on and from the point it should have been made aware (plus the amount it paid out for works that were not included in the facility agreement), less the amount by which its overall losses were reduced by ultimately realising its security.
So far so good for funders. Provided they are not contributory negligent (!) and engage their PMs on a robust retainer, a funder can expect recourse to a PM that is found to be negligent, and where such negligence causes loss.
The final and most recent case, Bank of Ireland and another v Watts Group Plc [2017] EWHC 1667 (TCC) concerned an allegedly negligent initial appraisal, rather than the PM's progress reporting and the drawdown process. The result itself represents something of a quadruple whammy for the funder. Not only did the TCC reject the funder's allegations of negligence, it held that:
- Even if there had been negligence, the claims failed on the grounds of causation. The funder was unable to show that, but for the allegations of negligence, it wouldn't have lent the money.
- The claimed loss was irrecoverable, because this was an "information" not an "advice" case for SAAMCO cap purposes.
- Even if the funder's loss was recoverable, it would have been reduced by 75% on grounds of contributory negligence, having taken on an unacceptable and unnecessary risk.
Of some note is the fact the court had regard to the modest fee charged by the PM for the appraisal, leading the judge to comment; "the size of the fee [is] good evidence of the limited nature of the service which Watts were expected to provide".
With memories of firework night fading into the November gloom, the decision adds further colour to the SAAMCO principles, such that the court confirmed that if a PM is found to be negligent, it will only be liable for the financial consequences of the information they provided being wrong. The damp squib for funders compounded by the fact the PM will not be liable for the financial consequences of the funder entering into the transaction.
The lesson for funders here is that decisions to lend should not be flawed, on their own analysis. Funders must follow their own lending policies and guidelines and not pass the buck to their PMs or waive funds through "because of the bank's pre-existing relationship" (per Watts). This point is worth dwelling on briefly. In cases like these the courts often make quite scathing observations as to the nature of so-called relationship banking and the apparently relaxed attitude to direct oversight and diligence on the part of funders. They are typically critical of banks' apparent reliance on their PMs to pick up the slack in their own diligence and processes, particularly when surveyors are on limited retainers. Perhaps not all the lessons of the GFC have been learned.
PMs will only be liable in law for the financial consequences of the information they provided being wrong, not for the financial consequences of the funder entering into the transaction (which could be quite different). Interestingly the TCC noted it was difficult to see how any specific loss could flow from the information about the estimated construction cost provided by the PM, because the funder had a cost overrun guarantee, which sought to cover them on that very issue. If the cost overrun guarantee then turns out to be worthless, that's the funder's responsibility, not the PM's.
Claims for contributory negligence also stand ready to erode any losses incurred.
From a finance lawyer's perspective at least, the PM's liability sits out of reach of their drafting in the finance documents. However, these decisions highlight the fact that adding the PM's certification to the drawdown process or dialling up their involvement in progress reporting and costs sign off should not be seen as a safety net, to capture liabilities not otherwise picked up by the borrower. Funders that decide take on risk for commercial reasons, and who may blame their advisors when adverse consequences of their decisions arise, should not count on a successful professional negligence claim.
The funder's checks and balances through the life of a development loan are best made from a position well-informed by the borrower and a suitably engaged PM (among other sources), and following its own lending policies and guidelines. Recourse should be through a comprehensive security package, including a full suite of properly-scoped professional appointments and interlocking construction contracts. For funders and investors, a good relationship with your borrower developer is to be encouraged although not at the expense of diligence.