Australia: Working with business to develop council land - 11 things a council must consider

A brief guide to negotiating development and lease agreements with commercial entities

Council's management plans deliver on the vision for their LGA to better serve and enhance the social and economic lives of their communities.

The master plans or management plans set the actions to turn the vision into reality and invariably include strategies for the development of council owned assets.

Often the realisation of the vision involves an agreement between council and a non-government commercial entity or organisation involving the development and lease of council owned land.

These agreements can be a win-win. Commercial organisations gain access to a valuable asset and council welcomes the investment, jobs and services they bring.

More than ever, Bartier Perry's team is being engaged to assist council clients in developing and documenting such transactions.

This article discusses 11 important aspects of these transactions, and offers practical steps to take and points to consider when contemplating entering into agreements relating to council owned land.

1. The most appropriate project delivery method

The typical development project sees council lease the developed land to the commercial entity as tenant. However, responsibility and payment for the development may take a number of forms:

• Council carries out the development in line with the tenant's design requirements and recovers the cost through a higher rent.
• The tenant carries out the development to the agreed design and the cost is reflected in a lower rent.
• The tenant carries out the development to the agreed design and is reimbursed by council. Rent is then set with no consideration of development costs.

Each method raises different concerns and risks to be considered by council such as:

• Is council equipped to carry out development works, particularly if they are for a specialised use such as health, aviation or highly automated warehouses?
• Can council carry out the development as efficiently and cost effectively as, say, a national retailer who has a blueprint and panel of selected contractors with a proven track record?
• If the tenant carries out the works, can council rely on the warranties and performance guarantees given by the builder (who was engaged not by council, but by the tenant)?

2. The negotiation framework

Having identified a preferred party to undertake development, council will then enter into discussions with that party. Before discussions start, council should consider agreeing to the following framework:

• An Exclusivity Agreement. Discussions of this type consume significant time, personnel and money. Accordingly, it is usual for one or both parties to seek an agreed period of exclusive dealings.
• A Confidentiality Agreement to govern the negotiation and disclosure of information.
• A Negotiation Protocol that sets appropriate standards of governance, probity and integrity for all discussions. It should expressly state that discussions are not an offer from council guaranteeing the interested party any contractual or other rights in respect of the land.
• The appointment of a probity officer or advisor to ensure the probity and integrity of the negotiation process.

3. Heads of Agreement/Term Sheet

Discussions will be aimed at reaching consensus on the key commercial terms of the proposed agreement. These terms will then be captured in a non-binding Heads of Agreement or Term Sheet.

The benefit of such a document is that it ensures both parties understand the commercial terms of the resulting agreement.

The document also allows council to seek formal approval of its councillors to proceed to the next stage, namely the drawing up of legally binding contracts of which the Agreement of Lease (AFL) is generally the primary document.

4. Landowner not consent authority

When negotiating commercial terms, councils should always be aware that they may be wearing two separate hats – as landowner/developer and as consent authority. It is essential that councils do not fetter their roles as consent authorities.

Concessions that can be granted by a private landowner cannot always be granted by councils. So it is important for documents to require the other party to acknowledge that council is a government body which must exercise its statutory responsibilities.

5. Standard of the works

It is imperative that the standard of the works to be carried out by the builder is documented. Ultimately, council may be required to reimburse the tenant for those works or even be responsible for their quality.

At a minimum, the completed works must comply with all legislative requirements, development consents and relevant Australian Standards, including the Building Code of Australia.

If the works are highly specialised (for example, a race track or a foreshore or public access development), it may be appropriate to agree on an existing development to provide the baseline standard required.

6. Warranties and performance obligations for the works for the benefit of council

If the works are carried out by the developer under a contract with the builder, it is highly likely that any warranties or performance obligations in the contract will not be assigned to council.

The agreement between council and tenant must address this by assigning warranties to council. Alternatively, council may enter into a tripartite agreement with the builder or consultant that provides for warranties to be provided to council directly.

7. Variation of the works

Works in most building projects are subject, at one stage or another, to variations.

The building contract will invariably include a regime for requesting, approving and valuing variations of works being carried out by the builder for the tenant. Such variations will generally result in:

• An extension of time for the builder to bring the varied works to practical completion
• Cost relief for the builder, with the contract sum payable by the developer to the builder adjusted to incorporate the price of the variation.

But how are variations of the works provided for in the AFL? Things to consider include:

• If the works are varied, does the rent payable under the lease require adjustment?
• If the works are varied and the development costs increased, does the sum to be reimbursed by council to the tenant require adjustment?
• To what extent is council approval required for a variation of the works?
• If council delays approval of a variation and works are subsequently delayed, is council liable for delay damages?

8. Security for the works

Under the building contract, the builder will generally provide security in the form of two bank guarantees, each to the value of 2.5% of the contract sum, to support its performance.

This security is available to the principal for such things as rectification of defects that the builder does not attend to, payment of liquidated damages, and claims arising from early termination of the building contract or from the insolvency of the builder.

Councils should also consider what security it requires to be provided by the tenant under the AFL to support the carrying out of the works. Council will suffer loss if the works are defective or if the tenant is not able or willing to compete the works by the agreed date. Damages sought would take into account:

• The cost of completing the unfinished works or restoring the land to its original condition
• Rectification of defects
• Loss suffered as a result of the tenant's insolvency.

9. Practical completion of the works and extensions of time

Under most agreements, the lease will commence and rental income will become payable to council around the date the development works reach practical completion.

Consideration must be given to:

• The date for practical completion
• Damages payable to council if the works are not completed on time
• The stage the works must reach to achieve practical completion
• How council will satisfy itself that the works have reached practical completion
• In what circumstances the date for practical completion can be extended
• A 'sunset date' beyond which no further extensions of time will be granted and the AFL can be terminated by council.

10. Intellectual Property

If the works are designed by the tenant or builder under a design and construct contract, council will require intellectual property rights in the design documents.

This will allow council to use and copy the design to whatever extent needed for any subsequent repairs, maintenance or servicing of the development, or later additions, alterations or further development of the land.

11. Lease

To ensure a return on their initial investment, tenants may require a long term lease, sometimes in excess of 50 years. Often the terms of such a lease will be different from those in a shorter term lease. For example:

• Permitted Use should be narrowly defined, to avoid the possibility of the premises being used in the future for something not supported by the community.
• Consider who will be responsible for repair and maintenance of the building over the long term to ensure it does not fall into gradual disrepair.
• Assignment. It is to be expected that during the life of a long term lease, the lease will be assigned to a new tenant who may not have the same financial strength or experience as the original. Consider putting security in place to cover any risk, such as bank or corporate guarantees. Parent company guarantees should be considered if a tenant wishes to transfer the lease to another company within the corporate group.

Parting thoughts

Agreements to develop and lease council land involve significant capital investment and long (sometimes very long) periods of tenure. The tenant will often seek rights that are generally the preserve of a landowner, not an occupier under a lease.

While such transactions can be rewarding for councils and may be demanded by their residents, councils must also assess the risks against the rewards, being especially mindful that during a 50 year plus lease council's master plans and community expectations will inevitably change.

You're invited

There's a lot for council to consider when negotiating these deals – more than we can do justice to in a single article. That's why we've developed a one hour training presentation which expands on these concepts. We can deliver it in person or online – whichever suits you best.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.