Forward Funding: the nature of this contract in Spanish judicial decisions and other considerations regarding the preliminary obligations of the parties

Written on 22 Dec 2016

The crisis in real estate and the irruption of foreign investment funds in the Spanish real estate market have led to the emergence of contracts rooted in Anglo-Saxon law such as forward funding in our legal system. In this article we analyse a few Spanish judicial resolutions published on the legal nature of this atypical contract as well as those issues that should be more accurately regulated in these types of contracts to avoid premature breaches.

The difficulty of finding funding in the real estate sector as well as the existence of multiple buildings and unfinished developments in our housing stock because of the crisis has introduced the contract figure of forward funding imported from the Anglo-Saxon culture in our country as a method of financing the construction or completion of real estate developments.

The speciality of this type of operation is that the contractual positions of a classic sale, the buyer and the seller, are mixed with the legal regime of promoters and investors of other types of contracts such as loan contracts made to promoters or turnkey contracts.

As has been defined by the Provincial Court of Madrid (Section 25) in its judgment dated November 23, 2012 number 585/2012, forward funding consists of the following: “The above-mentioned promotion contract, or forward funding, is found when the seller-developer transfers his right over a plot, and a project, committing himself to its integral development, so that the seller-promoter subsequently promotes, constructs and leases the buildings on other people’s land (as it has been already transmitted to the buyer-investor), acting as a promoter in the development of such tasks and assuming the inherent responsibilities. The buyer-investor acquires the works as they are executed, by accession, and, therefore, assures that the funds provided to the seller-developer (development finance) will revert to a work that is built on land that has become their property from the outset.”

Thus, as pointed out by Juan Antonio Pérez Rivares in his work “Considerations about the legal nature of the Forward Funding Contract” (Spanish Journal of Business Law No. 259), the question concerning the contractual nature of forward funding with respect to whether it is a genuine complex contract or the juxtaposition of several related contracts, will determine different consequences when interpreting it, in the case of any contractual conflicts as well as different obligations for the parties.

For the resolution of contractual conflicts regarding atypical contractual figures such as forward funding, the general theory of contracts determines four interpretive criteria:

  1. Theory of the Ferrara combination, by which the rules of the various contracts will be interpreted jointly;
  2. Hoeniger´s theory of absorption by which the law of the main contract dominating the atypical contract will apply;
  3. Theory of the analogy of Arcangelli and Roca Owalde in which another atypical contract of similar characteristics will apply;
  4. In addition, the intentionality of the parties in the regulation of the clauses would have to be taken into account;

In accordance with the hermeneutic criteria set forth, the Provincial Court of Madrid (Section 25) in its judgment 585/2012 has considered the interpretative criteria for the resolution of conflicts with regard to forward funding contracts offered by the theory of absorption and the theory of combination, although both theories should be tempered using the intentionality of the parties. In this case, the Provincial Court of Madrid (Section 25) understood that the dominant contractual figure of the forward funding contract was a sale contract combined with elements of loan and work lease contracts, as well as those of delegated promotion contracts or services leasing.

The Provincial Court of Valencia (Section 8) in its judgment of July 20, 2009 number 415/2009 determined on the basis of criteria closer to the theory of absorption than the nature of the contract of forward funding being prosecuted, was a service lease. The Provincial Court of Valencia concluded that the contract signed for the promotion and subsequent sale of a shopping centre following a scheme similar to forward funding should be considered a service lease considering that the technical and professional qualities of the agent contracted for the promotion and sale of the shopping centre had been determinant for the signature of the contract.

Furthermore, it should be pointed out that in these resolutions and also in judgment number 581/2010 issued by the Provincial Court of Madrid (Section 10) the facts being prosecuted are related to contractual breaches arising from the regulation of preliminary contractual actions. In the case of the two sentences issued by the Provincial Court of Madrid (Judgement 585/2012 and 581/2010), these preliminary actions were aimed at obtaining the building license according to a specific project, and in the case issued by the Provincial Court of Valencia (Judgment 415/2009), to obtain a percentage of previous commercialisation of the shopping centre premises that would later be built.

Both resolutions issued by the Provincial Court of Madrid and particularly number 585/2012 show the special importance of the regulation of these preliminary actions, especially with regard to the regulation of payments made prior to the commencement of execution of the work (if they are to be considered as seller-promoter’s fees or as marketing expenses, or as pre-payments necessary for the execution of the contract). It is also very important to define obligations that both parties acquire in this preliminary phase. Likewise, the Provincial Court of Madrid (Section 25ª) concludes that which party denounces the breach of contract in first place in order to request the resolution of the contract is crucial. The Court considers that some of the contractual obligations of a forward funding contract are bilateral in such a way that the breach of the obligation by one party will result in the successive breach of the other. In this case, the promoter-seller failed to comply with the deadline established for obtaining the building license, and also the license obtained provided for a percentage of building capacity different to the one contractually regulated, however, the investor-buyer did not denounce this fact, and as it was declared by court, his own actions determined that he wished to continue with the execution of the work. It is subsequently when the investor-buyer fails to fulfill their payment obligations that the seller-developer calls for the contractual resolution, obtaining the corresponding compensation, according to the conclusion of the Provincial Court, and against the criterion of the investor-buyer who considered that said payment had not occurred, deriving from the previous failure to obtain the correct license.

Lastly, it should be noted that given the scarcity of judicial decisions, and in accordance with the novelty of the phenomenon in our country, a subsequent jurisprudential development that will allow a specification of the regulation of this atypical contract must be expected. Although its nature is composed of different types of contracts, when drafting the contract it would be necessary to consider which contractual type is intended to be afforded more importance in order to correctly determine the obligations of the parties, taking into account the doctrine of interpretive absorption. Thus, as concluded in the book “Real estate promotion: design and construction” (VVAA: Ignacio Albiñana Cilveti, Juan Antonio, Pérez Rivarés, Jordi Viguer Pont, Silvia Reina Pardo, Open University of Cataluña) –buyer- investors will try to avoid the so-called delegated promotion contract prevailing (ex. Article 17 of the Spanish Building Management Act) to avoid their contractual obligations being assimilated to those of the promoters.