Assignment provisions are often found in construction contracts, including collateral warranties, and they are used to transfer the benefit of a construction contract from one party to another. When providing development and real estate finance, there are a number of issues lenders need to consider in relation to assignment of construction documents as part of their overall security package.
Benefits for a lender
If the benefit of a construction contract is assigned from a borrower to a lender, the obligations of the contractor or consultant are then owed to the lender and the lender can demand performance of the contractor's or consultant's obligations under those contracts. Assignment also allows the lender to enforce the terms of the relevant contract or pursue a claim against the contractor or consultant where they are in breach.
The lender may have the benefit of collateral warranties which creates a contractual link between the lender and the contractor or consultants. However, these will not usually enable the lender to enforce the terms of the underlying contract unless the lender formally "steps-in" and uses express rights and meets express conditions in the collateral warranties.
Assignment therefore makes enforcement more streamlined.
Legal assignment versus equitable assignment
The law recognises two different types of assignment – legal or equitable.
A legal assignment must be in writing, absolute and notice must be given to the other parties. An equitable assignment is not subject to the same requirements.
The main difference between the two types of assignment is that an equitable assignee (who benefits from the assignment) must join the assignor (the person who assigns their right) in any action against the contractor or consultant. A legal assignee can bring an action themselves.
In practice, equitable assignment is often preferred by lenders as it can be achieved in the debenture or facility agreement without the need for a separate deed of assignment and notices to the contractor or consultant. It also allows the borrower to retain the benefit of the construction documents so that they can continue to have the right to enforce the terms.
Charge versus security
Where a lender takes a charge over a contract, this gives the lender a right over the benefit of the contract instead of assigning it the benefit of the contract.
If the benefit of a contract is assigned by way of security, the benefit is transferred to the lender. On redemption of the loan, the lender will need to re-assign the benefit of the contract back to the borrower. This can be problematic where there is a limit on the number of permitted assignments and no carve out for assignment in this manner.
Where a contract contains an express assignment provision, common issues include:
- Assignment being restricted to absolute legal assignment, which means that equitable assignments are not permitted, including granting a charge
- Limits on the number of permitted assignments, which could have been wholly or partly used up already
- No carve out for assignments by way of security and reassignment on redemption which means that both assignments will count towards the permitted number, and will often use them up entirely.
It's important for lenders to understand what assignment options are available for construction contracts and assess whether they allow for sufficient security.