What do you need to do if your Spanish property developer goes bust?

Without any intended insult to the text of the Old Testament, the sub-prime disaster in the US begat market jitters, market jitters begat the collapse of age old financial institutions, the institutional collapse begat the credit crunch and the credit crunch begat the withdrawal of project finance.

Sprinkle lightly with a reduction in demand and an over supply and what do you have Spanish property developers falling off the perch, howling about liquidity issues and seeking creditor protection under the Spanish equivalent of Administrative Receivership (as in the UK) or Chapter 11 (in the US).

In the last month a company owning most of projects of the Grupo Jale, a major developer on the Costa del Sol, and Grupo Sanchez – equally big on the Costa del Sol – entered into Administrative Receivership and this week we heard that San Jose with projects in Murcia has sought similar protection.

Obviously in an already changed market, awash with fears for the security of hard earned money invested in Spanish property, this is not great news.

But where does this leave the property purchaser?

If you have already completed it is likely that your developer may not have sold his entire stock of properties at your new Urbanisation. This means that the developer will also become your neighbour, a member of your Community of Owners and be as responsible as you for their share – their quota – of community fees.

However, the effect of the appointment of an Administrative Receiver over the assets of the company will mean that your Community's will be required to deal with the office the Administrative Receiver and no longer with the developer themselves. Any subsequent sales of properties at your Urbanisation will generate cash for the Administrative Receiver's office. This will be used to pay out secured creditors – including the tax and social security offices – but it will also provide cash flow for the continuance of the company under the creditor protection. This means that the developer's employees – for example – will continue to be paid whilst the company attempts to trade its way out of trouble.

As a consequence, it is likely to be necessary to call either an Extraordinary General Meeting or an Annual General Meeting in order to protect the Communities position in respect of the unpaid Community Fees. I am told that only after these have been voted upon at the EGM or AGM will it enable the Community to enforce the unpaid fees as a debt against any incoming purchaser and thereby collect the unpaid balance. This may be an unpleasant surprise for the incoming purchaser – who's Abogado should have advised them on such matters and checked with the Secretary of the Community whether any such fees were outstanding. But the legal position appears to be only once the unpaid fees have been voted upon and passed into the Minutes of the Community that following a purchase will the incoming purchaser be obliged to assume responsibility for the unpaid fees. This should benefit the Community.

Alternatively, another potentially interesting scenario is starting to emerge – and we are seeking detailed legal advice on this point as I write. If like any other owner, the developer fails to pay their share of the community fees; will the remaining members of the community – probably a majority – be able to take legal action to recover the debt against the developer? Further should they be successful in obtaining judgment will the Community of Owners be able to obtain an "embargo" over the property to the extent of the Community Fee debt? As a consequence, will the Community then be able to progress to a "subasta" or auction sale of the defaulting owner's property to realise the unpaid Community Fees? Will this create an interesting new market of distress stock – whereby willing purchasers can acquire finished property at a knock down price?

We believe that this may be relevant where the developer, as is usual, has established an individual company vehicle to develop and sell a particular development. If they have sought creditor protection for only a member of the group of companies – rather than the individual development company – then the moratorium which prevents creditors taking action against the group member but may not apply to the individual development company. Careful review by an appropriately qualified professional is required as group wide creditor protection may operate to prevent a challenge by the Community of Owners.

What if you have not yet completed your purchase but you have paid over your deposit on signing your Private Purchase Contract (PPC) plus – possibly – several stage payments?

Under the terms of the PPC that you have signed, you will usually be acquiring an option to purchase the property at completion. This is not a property right as such but a debt owed to you by the development company with whom you've signed your PPC. As in English law, there are different categories of creditors. These include: "Secured" creditors who have registered charges against the development company's assets probably by way of mortgages or other loans – often manifested in an up to date Nota Simple of the property – the Spanish state tax and social security offices; "Favoured" creditors such as the company's own employees and "Unsecured" creditors.

Until completion it is usual that a property purchaser will be an "unsecured" creditor of the developer. This means that your rights in respect of your cash as deposited with the developer will mean that you rank behind the "secured" and "favoured" creditors.

Spain has a developed and legally backed system of Bank Guarantees (Aval Bancario). The Law 57/68 establishes a system of bank guarantees – or insurance policies – to protect the amounts paid by the buyers in case of the developer's failure to complete the development.  The aim is to ensure that you do not lose your money should the property not be built for some reason. This is usually offered by the main funding bank which has provided the developer with their project finance.

In practice, bank guarantees may not always reach the require level of protection as envisaged by the law. In our experience they need to be studied very closely to ensure that they are valid, up to date and signed by all relevant parties. To give you added comfort, you should seek from your Abogado written assurance that they have hold original versions of up to date – amended to include your deposit funds and any subsequent stage payments – fully signed and original Bank Guarantees from the developer's banker.

Should you find yourselves in a position where your developer has announced that they are entering into a formal creditor protection arrangement or they have filed for, Administrative Receivership, voluntary liquidation or similar you should consider whether it's appropriate to give your Abogado instructions to seek to call upon the bank's Guarantee. Whilst it may be difficult in practice to invoke this guarantee – it will usually require the intervention of your Abogado and possibly formal court proceedings – which may prove costly – it should provide you with long stop protection in the event of the collapse of the developer that results in the property not being constructed or completed.

It is not the intention to overly simplify this process and for one reason or another it is likely that the bank providing the guarantee – given the current financial climate – may seek to delay honouring or even refuse to honour their guarantee – so ensuring that your Bank Guarantee arrangements are at all times in "apple pie" order is very sound advice.

If you developer does not appear to be in financial difficulties we'd recommend that you review your Bank Guarantee arrangements in any event. A difficulty often arises if a date of expiry of the Bank Guarantee is specified on its face. Such a date may be an "in any event" date meaning that the Bank Guarantee will expire whether or not the property is "legally" completed. You should check with your Abogado to ensure whether such a date is stated in your case and he/she should apply to have them renewed before they expire. It is usual that the developer and the bank will need to sign each Guarantee and any extension to it which in our experience may well not happen if the developer and their financier are in dispute over other liquidity issues.

I have been approached by some purchaser's saying that their Abogados failed to advise them in relation to a Bank Guarantee. There may be one of two scenarios here. Firstly, the Bank Guarantee was issued in the usual way – as is required by the law – but for some reason the Abogado just didn't give the purchaser a copy. In which case, a note to your Abogado's office should reveal its whereabouts. Secondly – and of much more concern – is where either the Bank Guarantees has not issued for a variety of reasons. This may include that they were not requested by anyone including the purchaser's Abogado, were not offered or that they were issued and have now expired. Whichever way fully independent professional advice should be sought as to your available remedies against your advisors and the Administrative Receiver – or similar.

Finally, and this sounds like total stupidity, if your property is pretty much completed – snagging done etc. – but lacks – for example – the final formal licences from the local Town Hall – particularly the License of First Occupation (LIFO) – but – and this is an enormous but – your developer is threatening to file for creditor protection, Administrative Receivership or similar, it may be worth considering – if you are in a position to do it – to complete on your property in any event. For obvious reasons, care and professional advice must be taken if you are considering upon such a strategy – it may well be a massive gamble – e.g. the LFO may never be granted – but the net result of such completion will mean that the property is registered in your name. Instead of a debt owed to you by the developer you will have a property asset with an enforceable title.

Please note that the information provided in this article is of a general interest nature and intended as a basic outline only. It is not intended as any substitute for detailed legal or other professional advice specific to the reader's circumstances. Nothing contained in this article should be seen or taken as the writer or publisher providing legal or financial advice.