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Special Purpose Vehicles (SPVs) for construction contracts – should they really be avoided?

I recently contributed to a podcast for Place North West entitled “Building a better future for construction” [https://www.placenorthwest.co.uk/news/podcast-building-a-better-future-for-construction/]. The focus was very much on risk and striking a fair balance between employer and contractor. The demise of a number of long-standing North-West contractors should force the sector to look at how things can be done differently, and it was this thought process that set the tone for the piece.

Construction is complex with competing factors and agendas at play and potential solutions multi-faceted. I therefore just wanted to take a look at a specific area – the use of SPV’s.

How does an SPV work?

SPVs are widely used as a means of securitisation for property based financial products. In development and construction, SPVs are legal entities set up for a specific purpose to isolate risk. They are designed to prevent adverse risk being transferred to or from the owners of the SPV, the operations of which are limited to the acquisition and financing of specific property assets.

Should SPVs be considered risky?

 Employers, their consultants, and funders often perceive the use of SPV’s as risky.  The fear centres arounds the relative ease that an SPV could enter into insolvency leaving the employer and/or funder with a bloody nose in the event there is a contractual dispute or other underlying issue on a contract.

The Enron financial scandal back in 2001 gave SPVs a bad name. By ignoring transparency and exploiting a financial loophole, Enron was able to hide losses and overstate earnings. Whilst this first led to soaring share value, it ultimately caused its bankruptcy, leaving shareholders with massive losses and several directors being found guilty of fraud.

Lessons learnt from the scandal led regulators to adopt strong new measures, subjecting SPVs to much more scrutiny, governance and transparent reporting.

The positives associated with SPVs should not be overlooked.

What are the benefits of SPVs?

Contractors are often able to use cashflow generated from a particular contract elsewhere within the business. Funds can be used to support problem or loss-making jobs which may or may not eventually turn around, or for general working capital.

The larger the number of contracts within one legal entity the risk of failure becomes potentially greater. One bad job can quite easily cause irreparable damage as we have seen on more than one occasion.

The potential isolation or reduction of risk through use of an SPV could be worthy of consideration.

An SPV still has the ability to lend funds to related businesses and this is where some form of ring-fencing arrangement would be required.

The creation of an SPV can sometimes lead to lower funding costs when the assets to be purchased and owned by the SPV are judged by lenders to be a greater quality of collateral that the credit quality of the sponsoring corporation.

Employers will often obtain a detailed credit report on the contractor and review their accounts. The view may well be that the contractor has a strong balance, and it is unlikely that they would let the company go bust.

Whilst I understand this viewpoint it can be fundamentally flawed. This viewpoint is often taken based on outdated financial or management information, often produced in-house and unverified. Engaging with an SPV can be problematic due to a lack of credit history and this is of course a factor. Guarantees from other entities could come into play.

It’s worth mentioning that SPVs in the form of limited companies, partnerships or trusts can be registered outside the country of operation, and this can be used as a strategy to avoid tax that would otherwise be payable.

Whilst I am certainly not advocating the use of SPV’s without much deeper analysis, I think we should at least start to challenge traditional norms. Something has to change otherwise we will continue to see insolvencies in the sector which really do not do anybody any favours!

Disclaimer

The information was correct at time of publishing but may now be out of date.

Property
Posted by Stuart Stead
8th April, 2021
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