In a forward purchase structure, the parties agree to sign a sale and purchase agreement, either for the shares of the company owning real estate under development of for the real estate itself, under the condition precedent of the completion of the works (being in most cases the provisional acceptance). Transfer of ownership therefore occurs only after provisional acceptance, meaning that the investor-buyer will neither bear the construction risk nor the risk of insolvency of the developer-seller. This could also ease the financing of the transaction, such financing being most of the time negotiated before signing but with a draw-down only on completion.
Most of the time, there is no down-payment from the investor-buyer to the developer-seller on signing but this depends on commercial negotiations. Still in terms of pricing, we often see that the vacant spaces are valued at ERV (Estimated Rental Value) and that the forward purchase is accompanied by an incentive for the developer-seller to let the premises at pre-agreed conditions and to benefit from an earn-out in case of successful letting within an agreed period of time.
In a forward funding structure, the parties agree to sign a sale and purchase agreement, either for the shares of the company owning real estate under development of for the real estate itself, without condition precedent of completion of the works. To mitigate the risk for the investor-buyer, parties usually agree on a condition precedent of definitive permits.
Contrary to the forward purchase, the sale - and thus the transfer of ownership – occurs prior to the completion of the construction works and the price is paid upfront, most of the time in installments over the construction process. It also means that, except for the regulated forward funding under the Breyne Act, the parties have to contractually agree on the process and allocation of risks during the entire construction process.
Because the investor-buyer is on board at an early stage, it can tailor the development and remain involved throughout the development process. From a pricing standpoint, we usually see the same incentives as for a forward purchase. From an economic standpoint, both parties should measure the impact of early payment on their own return; the developer-seller benefitting from an absence of upfront funding of the project but the investor-buyer being required to call capital at an early stage without presenting rental revenues. External financing agreements are also tailor-made for this type of transaction since the parties will (strictly) agree on the conditions to be met for drawdown during the construction phase.
The forward funding has a higher risk profile for the investor-buyer (and its lender) since the investor-buyer will be exposed if the developer-seller does not perform or becomes insolvent. Forward funding structures usually require more complex transaction documentation (such as a more extensive sale and purchase agreement, detailed and accurate specifications of the real estate development, development management agreement and a letting mandate).
To mitigate its risk, the sale documentation should contain appropriate protection mechanisms for the investor-buyer to cover notably the insolvency risk of the developer-seller (such as step-in rights, escrow and guarantee).
Breyne Act: the only regulated forward funding
The Breyne Act of 9 July 1971 applies to forward funding in asset deal for residential assets. This is the only forward funding regulated under Belgian law.
The application of the Breyne Act is excluded when the usual activity of the investor-buyer is to build or to have built properties in view of their sale. It is moreover required that the investor-buyer executes one or more payment(s) before the completion of the works.
The Breyne Act offers notably the following guarantees: (i) the down payment cannot exceed 5% of the total price, (ii) the balance of the price is paid in instalments gradually depending on the state of completion, (iii) the transfer of the ownership occurs gradually, based on the payments executed although the risks are transferred to the investor-buyer on provisional acceptance. The type of guarantee depends whether the developer-seller is recognised as registered contractor. Registered contractors are obliged to post a financial guarantee equal to 5% of the total price to the Caisse des Dépôts et Consignations. This guarantee is released for the half on the provisional acceptance and for the balance at final acceptance. Other sellers are required to deliver a completion guarantee (e.g. bank guarantee) covering all sums necessary to complete the works or to reimburse the sums paid by the (future) owner in case of termination of the contract because of non-completion of the works.
Other forward funding transactions (e.g. non-residential assets, share deal) fall outside the scope of the Breyne Act. In general, we notice that the parties apply most of the time similar principles in their contractual agreements.
Using forward structures requires investor-buyer’s increased attention.
In a forward purchase structure, the due diligence is very important. The investor-buyer should perform (i) prior signing the sale and purchase agreement, an in-depth due diligence in terms of zoning/permits and construction, also from a technical point of view, to clearly identify what it buys and (ii) shortly before closing, a confirmatory due diligence to ensure that the built asset complies with the agreed construction program.
In terms of contractual provisions, without being exhaustive, the investor-buyer should negotiate (i) appropriate conditions precedent (being in most cases the provisional acceptance of the works), (ii) a procedure in case of modification of the construction program, encompassing the consequences of such modification on the construction price, the value of the asset or on the leasable surface of the asset and (iii) valuation mechanism of the vacant spaces at closing, including an earn-out mechanism as the case may arise.
In a forward funding structure, the due diligence is usually limited, especially when the real estate project is still at an early stage.
However, we recommend the investor-buyer being particularly cautious when signing the sale and purchase agreement. The investor-buyer should negotiate (i) a detailed timing of the construction works with appropriate penalty mechanism to ensure the timely completion of the works, (ii) a condition precedent relating to the granting of definitive permits covering the construction and the operation of the asset, (iii) a (bank) performance guarantee to ensure the achievement of the works, (iv) a condition subsequent/long-stop date to step out of the project in case of significative delay, (v) a payment schedule, (vi) the rental conditions at which the developer-seller can lease the asset as well as a letting mandate and (viii) the obligations and responsibilities of the developer-seller in terms of completion of the development; this can be implemented in a separate project development agreement.