Whether Works have, or have not, reached practical completion is a regular contentious issue on a project and can be a more common source of dispute in these recessionary times. Although the terms ‘practical completion’ or ‘substantial completion’ are widely used in construction contracts, the standard form contracts do not provide clear definitions.

The express pro-visions tend to leave the decision as to whether the works have reached prac-tical completion entirely to the discretion of a certifier.

The problems are further compounded when, in the real estate or property sector, there is a related but independent con-cept of ‘Completion’ under the Development Agreement or Agreement for Lease. The question then becomes whether the building or development has reached physical ‘Completion’ such that financial and land law completion is triggered. This concept, coupled with long-stop or back-stop dates after which a Purchaser or Tenant can simply ‘walk-away’ from the transaction, means that practical completion is at the very centre of the commercial transaction.

In this article, Hamish Lal examines how ‘Completion’ of the asset to be purchased (or leased) sits within typical Agreements for Lease, considers ‘Completion’ in the underlying building contract and the interrelationship between the two agreements. The analysis follows English law and UK property development, but the principles of law and practice have similarities to other jurisdictions and sectors.

AGREEMENT FOR LEASE: COMPLETION

The importance and relevance of the state of completeness in the context of commercial real estate agreements was summed up recently by Warren J in Menolly Investments v Cerap [2009] EWHC 516. In that case, in essence, the Purchaser of a development with address 107 Cheapside in the City of London argued that the building was not ‘complete’ for the purposes of the Share Sale Agreement and that the developer, having failed to procure the completion of the building by the long-stop date allowed the purchaser to walk-away from the transaction. The commercial imperatives for the Seller and Purchaser are tangible and the subjective commercial drivers are equally transparent. The Court summed up the issues as follows:

The dispute arises out of a contract dated 22 December 2006 (“the Share Sale Agreement”) made between Menolly and Cerep, under which Menolly is to purchase the issued shareholding in Cerep Cheapside S.A.R.L (“Cerep Cheapside”) and two other companies. Menolly Homes is also a party to the Contract in order to guarantee Menolly’s obligations under the Contract. The Building is owned by Cerep Cheapside. Completion of the SPA is dependent on, among other matters, on practical completion of certain building works in relation to the Building.

Agreements for lease do, of course, vary but a typical inclusion is an
express clause dealing with the developer’s obligation to build the
particular asset. Understandably, Developers do not like absolute obligations that something will be built and that they will build it. Instead, the orthodox preference is that developers will simply use their ‘reasonable endeavours’ to enforce the terms of a building contract (which may have been commented up by the Purchaser). The counterbalance is that the Purchaser will usually insist that its consent is required before material variations or modifications are made to the terms to the building contract and the actual works covered by the building contract. Ultimately, (driven by the commercial market conditions) it is common for purchasers to insist on an express term making it clear that should the building or development not be complete by a certain date then the purchaser no longer has an obligation to purchase commensurate with the Agreement for Lease. This is a fundamental commercial issue since, in practice, when the long-stop date has been breached, there is nothing to prevent the parties from reaching a compromise on the additional time to complete the development and of course cost. This is all driven by the market (and hence why the recession is so material). A typical (simple) clause in an Agreement for Lease would read:

“The Developer shall use all reasonable endeavours to procure that the Building Contractor shall proceed with and complete the Works in a good and workmanlike manner, using good quality materials, in accordance with the terms of the Building Contact and shall use all reasonable endeavours to procure that the Building Contractor reach Practical Completion of the Works on or before [x date] provided that this date shall be extended by a period equal to any extension of time awarded under the Building Contract...”

The purchaser/tenant is allowed to attend the site inspections leading up to the certification of completion and to make representations to the architect or employer’s agent. However, it is usually the case that such representations are not binding on the certifier and the certificate or statement of practical completion is issued by the certifier using its sole discretion. Tempting as it may be to challenge the certifier, either directly (under a collateral warranty and/or via an injunction) or indirectly (through the agreement lease) there is little case law to lend encouragement. One case that may be relevant is Scheldebouw BV v St James Homes (Grosvenor Dock) Ltd [2006] EWHC 89 (TCC) makes it clear that Employer’s Agents is a decision maker and as such is required to act in a manner which may be described as independent, impartial, fair and honest. Jackson J (as he then was) stated:

“... decision-maker must use his professional skills and his best endeavours to reach the right decision, as opposed to a decision which favours the interests of the employer”

The fact that certification of completion is divorced from the overriding
agreement for lease; that a Purchaser can do little to influence the certifier; and that the developer’s obligations with respect to completion are expressly linked to completion under the building contract all explain why ‘completion’ under the building contract is the focal point of disputes in this sector.

BUILDING CONTRACT: COMPLETION

The terms ‘completion’ and ‘practical completion’ under the UK’s JCT forms of building contract have been held by the Courts to be the same concept. This was established in Emson Eastern Ltd v EME Developments Ltd (1991) 55 BLR 114 where HHJ Newey QC considered that an architect had to be reasonably satisfied that the work has been properly and fully completed in all but minimal respects. The judge took a pragmatic view stating:

“... building construction is not like the manufacture of goods in a factory. The size of the project, site conditions, use of many materials and employment of various types of operatives make it virtually impossible to achieve the same degree of perfection as can a manufacturer. It must be a rare new building in which every screw and every brush of paint is absolutely correct.”

Unless there are bespoke amendments placing specific preconditions on the definition of Completion or Practical Completion, it is the caselaw that is most instructive and provides the best guidance for purchasers/tenants on whether to challenge the certificate of completion.

The most recent guidance comes from Menolly which considered the House of Lords and Court Appeal reasoning in the case of Jarvis & Cons v- Westminster Corpn. [1970] 1 WLR 637. The test for ‘practical completion’ was considered to be as follows:

“One would normally say that a task is practically completed when it was almost but not entirely finished, but “practical completion” suggests that that is not the intended meaning and that what is meant is the completion of all construction work that has to be done.”

 In the Court of Appeal in the same case, Salmon L.J analysed the words in these terms:

“The obligation upon the contractors under clause 21 to complete the works by the date fixed for completion must, in my view be an obligation to complete the works in the sense in which the words “practically completed” and “practical completion” are used in clauses 15 and 16 of the contract. I take these words to mean completion for all practical purposes, that is to say, for the purpose of allowing the employers to take possession of the works and use them as intended. If completion in clause 21 meant completion down to the  last detail, however trivial and unimportant, then clause 22 would be a penalty clause and as such unenforceable…..”

The learned Judge in Menolly was invited by Counsel for the purchaser to conclude that the phrase ‘practical completion’ as ordinarily used in a standard form contract now means and is accepted by common usage to mean “complete for all practical purposes”. The concept of ‘purposes’ and linking the state of completion with the end-use of the building was not further explored in Menolly.

Instead, the Judge agreed that:

“Practical Completion is perhaps easier to recognise than to define. No clear answer emerges from the authorities as to the meaning of the term.”

In Mariner International Hotels Limited v Atlas Limited FACV No.3 of 2006 the Court of Final Appeal of Hong Kong considered whether in determining if a building was practically complete it had to be complete before handover or if works could continue if the building was capable of being opened and operated for its intended use.
 
The case concerned a hotel: the purchaser argued that practical completion meant “a state of affairs in which the Hotel has been completed free from any patent defects other than those ignored as trifling”; the vendor argued that it meant “no more than a state of affairs in which the Hotel is capable of being opened for business even though works are still being continued”. The Court preferred the purchaser’s arguments.

PRACTICAL CONCERNS

Given the independent relationship between the underlying building contract and the more important Development Agree-ment/Agreement for Lease, it is clear that any ‘challenge’ to the certification of completion needs to be founded on the definition of ‘practical completion’ or ‘Completion’. This is in turn founded upon the scope of work under the building contract. The case-law appears to afford Certifiers certain latitude in assessing whether certain patent defects or omissions are suf-ficient to preclude certification.

This latitude causes several difficulties. Firstly, it makes it difficult for purchasers to argue  (during inspection stages and in representations) that there must be no defects at all in the Works beforecertification of completion. Typically, Development Agreements will make Certificates of Practical Completion issued under the building contract final and binding on the Seller and Purchaser for the purposes of triggering financial and legal completion of that agreement. Whilst ‘manifest error’ may be expressly stated to be sufficient to unravel the certificate, the above mentioned latitude makes it difficult (but not impossible) to argue that that the architect or employer’s agent has made a manifest error when assessing the state of completeness. Menolly and indeed other cases show that there are significant benefits for purchasers to make certain matters an express condition precedent to the certification of practical completion under the Building Contract and/or the Agreement for Lease/Sale Agreement. If the process is not so codified then the architect or employer’s agent has discretion (as explained in the case-law) which may be difficult to challenge. Ultimately, parties seeking to vacate the deal are advised to engage fully in the inspections leading to certification.

The precise scope of works and the various contractual documents ought
to be considered too in case the certifier has made mistakes in interpreting certain documents or considered matters outside the scope of the building contract.

One misconception is that there can be patent defects in a building and so long as these are ‘trifling’ there is no impediment to certifying practical completion. The greater concern for Developers and Purchasers is if there are certain non-trifling patent defects and practical completion has still been certified. There is a risk that the certificate may be successfully challenged and whilst valid under the building contract may not have the intended impact in the Agreement for Lease.

Given the fundamental importance of ‘practical completion’, the inherent risks with the common law definitions and the approach in the standard forms (eg JCT 2005 (With Quantities) Clause 2.30: “When in the opinion of the Architect/Contract Administrator practical completion of the Works or a Section is achieved...”, perhaps it would be mutually beneficial to define in express terms (in the building contract) exactly what ‘practical completion’ isintended to certify?

Hamish Lal is a partner at Dundas & Wilson LLP’s Construction and Engineering Team, London (email: Hamish.lal@dundas-wilson.com )