As first published in Social Housing, 6 June 2019.
As widespread remedial works continue, Mark London and Julian Barker look into the legal and financial implications for housing associations.
Following the Grenfell tragedy and the publication last December of the Ministry of Housing, Communities and Local Government’s (MHCLG) Advice Note 14, registered providers (RPs) have been inspecting the external wall systems on their tall buildings.
In the vast majority of cases, defects have been found in these systems, either in the choice of materials used (readily combustible cladding and/or insulation) or in workmanship (missing or defective cavity barriers).
The implications for RPs are stark, and in most cases high-value remedial work will be required. In this article, we consider some of the financial implications.
Let’s remind ourselves of the context that gave birth to Advice Note 14.
Most readers will be aware that in December 2018 the building regulations were amended to ensure that, with some limited exceptions, anything that is to become part of an external wall system of a building taller than 18 metres must be of limited combustibility and achieve a European classification rating of A2 or better.
At a stroke, the government has outlawed the use of readily combustible materials within external wall systems of tall buildings. Insofar as the building regulations provided a degree of ambiguity prior to the amendment, that ambiguity has been well and truly scotched.
But there is one inherent difficulty: it is not retrospective. While the amended building regulations will likely apply to stock in planning, they do not apply to buildings that are already built and occupied. This is where Advice Note 14 comes in.
The MHCLG issued Advice Note 14 shortly after the changes to the building regulations, to set out its understanding of the duties owed by a responsible person in respect of a tall building under the Regulatory Reform (Fire Safety) Order 2005.
In a nutshell, the MHCLG has said that in order to discharge the obligation to take general fire precautions to keep residents safe, it is necessary to inspect the external wall systems of tall buildings.
Where the external wall system does not comprise of readily combustible material, it is still necessary to check whether the system has been adequately installed and maintained (ie are the cavity barriers in place and functioning as they should?).
Where the system does comprise readily combustible materials, it will still be acceptable provided there is a BS 8414 test to demonstrate compliance with building regulations. Where there is no such test, advice must be sought as to what remediation, if any, is required.
Although Advice Note 14 can be criticised as being a somewhat strained interpretation of the duty to take general fire precautions, and in that it is only guidance, we can nevertheless expect the approach to be given legal effect in the new regulatory regime that is expected following Dame Judith Hackitt’s report. In that regard it would be unwise to ignore it.
Dealing with issues
What we are seeing across the sector, as a result of investigations carried out in the wake of Advice Note 14, is the need for widespread remedial works on tall building stock. In a significant number of cases this includes the wholesale replacement of the external wall system.
Recovering the costs and other losses associated with these works is one issue, but the immediate financial implications for RPs is another altogether.
So what are the financial implications? The cost of remedial works to tall buildings can, as we have seen, be very significant indeed and may therefore affect an RP’s ability to comply with any financial covenants in its bond and/or private placement documentation.
This is of particular significance where interest cover covenants are calculated on an EBITDA MRI basis as this specifically deducts from operating surplus the cost of major repairs, such as those necessitated by following Advice Note 14.
Even in the event that major works are not factored in to a calculation of a provider’s financial covenants, the substantial costs of interim measures pending the completion of any major works, increased insurance premiums and the cost of relocating residents (where necessary) are not to be underestimated and will also affect an RP’s cash flow and cash reserves.
Further, although it has been confirmed that tall buildings can still be used as security, the widespread uncertainty caused by the Grenfell tragedy has created a number of valuation issues.
Valuers are dealing with this uncertainty by including ‘abnormal uncertainty’ clauses in their valuations of tall buildings on the basis that they cannot say for certain how the properties’ value would be affected, even two years on.
In addition, the EUV-SH methodology used to value social housing properties takes into account the cost of repairing and maintaining a property. Although in some circumstances the remedial costs will not make much of a difference to the EUV-SH value, in other circumstances the remedial costs can materially decrease an EUV-SH value.
Any such decrease in value could then affect an RP’s ability to comply with asset cover covenants in debt documentation. The provider may then have to go through the process of charging further properties or putting up cash to avoid any breach.
Ultimately most providers will have a recourse to loss recovery through one or more of the original contractors, the supply chain members who have provided collateral warranties, a latent defects insurer and professional indemnity insurers.
However, that recovery is unlikely to fully compensate the provider for its losses. It is a truism of construction law, just like any other, that there is no certainty of recovery.
Tall buildings that were constructed more than 12 years ago – that are not exempt from Advice Note 14 – may give rise to issues with limitation.
Grenfell has shone a spotlight on a widespread problem with quality within the sector, the depths of which are only now being fully appreciated. While the health and safety consequences of this are obvious and direct, the potentially serious financial implications must not be overlooked.
Mark London and Julian Barker, partners, Devonshires.