Restoration bonds: escrow agreements versus bank guarantees

From solar farms to gravel extraction, landowners often want protection from the risk that a tenant will fail to restore the land in accordance with planning conditions. Requiring the tenant to provide a “restoration bond” is the usual solution, so that even if the tenant defaults, the landowner can access funds and carry out the restoration work themselves.
“Restoration bond” is a broad term that can refer either to an escrow arrangement or a bank guarantee – very different beasts. What are their key features and what are the issues?

Escrow arrangement

An escrow arrangement is an arrangement between a landowner and a tenant whereby the tenant deposits funds into a bank account as security for financing the restoration obligations. These funds usually remain in the account until the end of the lease when they will either be returned to the tenant, if they have restored the land to the agreed standard, or to the landowner if not.

Points to consider

• Who controls the account? Because neither the landowner, nor tenant, will want the other to have a free hand to dip into the account at any time, it is usual for escrow accounts to be held in joint names. An alternative approach for large restoration bonds is for the parties to appoint a third-party “escrow agent” to deal with the administrative burden and day to day running of the account. Most commonly it will be agreed that, unless and until the tenant is in default under the lease, the escrow agent will need to be jointly instructed by both the tenant and landowner to make a withdrawal.
• Amount to be held: usually, prior to the start of the lease, the landowner and tenant will estimate the projected restoration costs to return the land to the agreed standard. This sum (or an agreed proportion of it) will then be deposited into the escrow account on or before the start of the lease. Sometimes, a tenant will argue that the deposit should be postponed to a later date, say year 10 or 15 of the term. A landowner should resist this if possible and insist on a deposit from the outset, so that they have at least some money to call on if the project becomes unviable and the tenant becomes insolvent or they otherwise breach the terms of the lease.
  
  The escrow arrangement will often also include provisions requiring further deposits to be made throughout the term of the lease, to reflect changes to the estimated restoration costs. A five yearly review cycle is common and, like a rent review, often provides for expert determination if the parties cannot agree any additional sum due between themselves.
• Releasing funds: the escrow arrangement will contain a mechanism governing how and when the landowner can use the funds if the tenant defaults, but will also contain provisions about when funds will be returned to the tenant. The tenant may want to use the funds in the escrow account to restore the land, but it is unlikely that a landowner would be comfortable with a tenant having unrestricted access to the funds. These arrangements commonly include conditions that must be met prior to the tenant being put in funds, such as an obligation to provide a budget and / or work schedule to the landowner for approval first.
  
  

Advantages

An important advantage of escrow arrangements from a landowner’s point of view is that, unlike a bank guarantee, there is real cash in a pot which the landowner has direct rights to access if the tenant defaults. This can offer the landowner greater protection if the tenant becomes insolvent.

Another advantage is that it does not involve any third parties; the landowner only has to deal with the tenant to prove default and access the funds. With a bank guarantee, by contrast, the landowner will have to satisfy the bank that the tenant is in default. Finally, it is arguable that a tenant is more incentivised to fulfil their restoration obligations under an escrow arrangement, because fulfilling those obligations is their only way of recovering their money.

From a tenant’s perspective, an escrow arrangement is likely to be cheaper, because it avoids having to bring in a third party, which will charge for its services (escrow agents aside, whose fees are likely to be limited). A bank will probably also require an indemnity from the tenant (or a guarantor) in respect of the guarantee, which is all extra work. That said, there are times when a bank guarantee may be preferred or required.

Bank guarantee

A bank guarantee is a promise made by a lending institution to the landowner to cover a loss incurred by a tenant. Where a tenant defaults on its obligation to restore the land, the landowner can serve notice on the bank requiring them to release funds for the work. Bank guarantees tend to be short documents on the bank’s standard terms and there is unlikely to be much scope for negotiation.

Points to consider

• Liability caps: a bank is unlikely to agree to an unlimited guarantee and the landowner and the tenant will need to agree the initial restoration figure, which the bank will then guarantee. If the figure needs adjusting further down the line, an updated limit or new guarantee will need to be obtained from the bank.
• Enforcement: although the guarantee document itself is likely to be standard, the bank may want input on the trigger provisions in the lease, setting out when the landowner can call on the guarantee. The bank may insist that the guarantee is only enforceable where the tenant has actually failed with their restoration obligations and proof of that failure can be supplied, whether by way of a court judgment or expert opinion, for example. This potentially means a landowner has to incur costs before they can call on the guarantee to remedy matters.
  
  

Advantages

The main advantage of using a bank guarantee is that the tenant will not need to provide funds upfront which will then be put beyond use for the duration of the lease. Clearly this can create difficulties with cashflow, if the tenant does not have funds readily available, or wants to use all available funds for the initial development of the project. A guarantee also saves both parties the additional burden of having to manage an escrow account.

Escrow arrangement or bank guarantee? Which one you chose is a case of “horses for courses”. Where you have a tenant which is a newly created special purpose vehicle with few or no assets (effectively just a shell company), a guarantee may be the only viable option. Where the tenant is more established, or where the final cost of reinstatement is difficult to quantify at the outset and will require constant review, an escrow account may prove more suitable.

This article is part of the Rural Estates Newsletter 2024, click here to read.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, February 2024