Cost Overruns: Who Covers Them
Every construction budget is a forecast, and forecasts miss. Ground conditions surprise, tender prices move between estimate and contract, a delay turns into months of additional interest, and a building that was priced on drawings meets the reality of being built. None of this is exceptional. It is the normal weather of development, and everyone who finances construction professionally plans for it.
The question that matters is therefore not whether costs will deviate from the budget, but who covers the difference when they do. In a well structured financing, that question is answered before anyone signs, in the building contract, the facility agreement and the sponsor’s undertakings. If the question is being asked for the first time in the middle of the works, with invoices on the table and a facility that is running out, it was left unanswered when answering it was cheap. This piece sets out where overruns actually land, how the structure absorbs them, and what happens in the projects where nobody made a plan.
The loan does not grow with the building
The starting point is a fact developers sometimes discover late: the bank’s commitment is fixed at signing. A development facility is sized against a specific cost plan and a specific expected end value, approved through a credit process that examined both. When the cost of the works rises afterwards, the facility does not rise with it. There is no automatic mechanism by which the lender funds the difference, and requests to enlarge the loan mid-project are treated as what they are, a new credit decision on a project that has just demonstrated that its budget was wrong.
This is not rigidity for its own sake. The bank priced its risk on the numbers it approved, and its protection lies in the margin between total cost and end value. Every euro of overrun eats that margin from the lender’s side if the lender funds it, which is precisely why the lender will not. Structurally, overruns belong to the party that owns the upside of the project, and that party is the developer. The debt is entitled to its repayment, not exposed to the building costing more; the equity is entitled to the profit, and therefore carries the risk that there is less of it.
The practical consequence runs through the whole documentation. Development facilities commonly include a cost to complete test: before each drawdown, the lender or its monitoring surveyor checks that the undrawn facility plus any remaining committed equity still covers the cost of finishing the building. The moment that test fails, drawdowns can stop, not as a sanction but as arithmetic. A lender that keeps funding a project whose remaining money no longer reaches the end is not financing completion. It is financing a larger unfinished building, and no lender signs up for that.
Developers who have mostly borrowed against income-producing assets sometimes find this regime severe, because investment lending rarely watches the borrower this closely. The comparison misses what is different about construction. An investment loan is secured on an asset that already exists and already pays; a development loan is secured on a promise that a budget and a programme will turn money into an asset. The lender’s entire position depends on that conversion completing, which is why the discipline around cost sits at the centre of the documents rather than in an annex. Understanding that logic before signing makes every later conversation with the bank considerably easier to have.
The contractual map: where an overrun lands first
Before an overrun ever reaches the financing, it passes through the building contract, and the building contract is where the first allocation happens. A genuine fixed price contract transfers a large part of the pricing risk to the contractor: if the works cost more to deliver than the contract sum, within the agreed scope, that is the contractor’s problem. A cost-plus or remeasurement contract leaves that risk with the employer, which is to say with the developer. Lenders read the building contract with exactly this question in mind, because the label on the cover matters less than the clauses inside.
The clauses inside are where fixed prices quietly stop being fixed. Price revision mechanisms linked to material costs, broadly drafted provisions for unforeseen conditions, generous grounds for extensions of time with associated costs: each is a door through which an overrun walks back to the developer. So are variations. Every change order the developer signs, every upgrade and every late design decision is, contractually, the developer’s own cost, however reasonable it seemed at the time. A large share of what gets described afterwards as an overrun is in fact an accumulation of decisions, each one signed for.
There is also the allocation nobody likes to discuss: contractor failure. A fixed price is only as strong as the company that gave it, and a contractor priced so aggressively that the project pushes it into distress converts the best contract into the worst outcome, a half-finished site, a retendering at current prices, and a delay measured in seasons. This is why lenders examine the contractor’s covenant, its workload and its financial standing, and why guarantees and step-in rights exist. The cheapest tender is not automatically the cheapest building.
The developer’s residual position should be understood without illusion. After the contract has allocated what it allocates, everything that remains is the developer’s: the variations, the excluded risks, the delay costs, the gap left by a failed counterparty. The contractual map does not eliminate overruns. It determines how much of them arrives at the developer’s door, and how fast.
The structure’s defences, in the order they are used
A properly structured development financing does not meet overruns with improvisation. It meets them with layers, and the layers are used in order. The first is the contingency: the funded reserve inside the approved budget, sized against the real risks of the scheme, controlled so that it is spent on genuine unknowns rather than on preferences. While the contingency lasts, an overrun is an accounting event, not a crisis. The project absorbs it and the works continue.
The second layer is the sponsor. Development facilities routinely include a cost overrun undertaking, under which the sponsor commits to fund costs above the contingency so that the cost to complete test keeps passing. This is the written answer to the question in this article’s title: above the contingency, the developer’s shareholders cover them, and they have signed to that effect before the first drawdown. The strength of the undertaking is part of the credit decision itself, which is why lenders look at the sponsor’s balance sheet and not only the project’s.
Around both layers sits the machinery that keeps deviation visible early. Drawdowns are released against certified progress of the works, with an independent monitoring surveyor comparing what has been built and what has been spent against the plan. In one Dutch project financed in a separate land tranche and construction tranche, disbursements were linked to certified progress precisely so that any drift between budget and reality surfaced while there was still capital and time to correct it, and the project kept the means to finish. Certification is sometimes experienced by developers as friction. It is better understood as the early warning system that makes every other defence usable.
When nobody covered them
The projects that end badly are rarely the ones with the largest overruns. They are the ones where the overrun arrived and found no layer waiting: a contingency already consumed by scope changes, a sponsor undertaking never required or never enforceable, a monitoring process treated as paperwork. The sequence from there is well known. The cost to complete test fails, drawdowns pause, the contractor slows and then demobilises, and the site acquires the most expensive status in real estate: stopped.
A stopped project inverts the economics of everything around it. Interest continues to run, the site must be secured and insured, the contractor’s claims accumulate, and the asset itself, a partially built structure, is worth substantially less than the money already spent on it, because its only buyer is someone who must price the cost and risk of finishing another firm’s half-finished work. Time, which in a running project builds value, in a stopped project only destroys it.
Weakness then does the negotiating. New money, whether from the existing lender, a new lender or an incoming partner, knows exactly what the alternative to its terms is, and prices accordingly. The developer who would not fund a contingency at the outset ends up paying many times that cushion in margin, fees and surrendered control, and sometimes in the project itself. None of this is bad luck. It is the predictable cost of leaving the central question of construction finance unanswered until events answered it.
There is also a quieter casualty in these situations: the developer’s standing for the next project. Construction lending is a small world in every market, and the file of a financing that ended in a standstill follows its sponsor. The developer who absorbed an overrun through a properly sized contingency and a sponsor undertaking has, on paper, an uneventful project; the developer whose site stopped has an explanation to give in every future credit committee that considers his name. The cost of an uncovered overrun is therefore not only what it takes to restart the works. It is priced into the terms of financings that have not been signed yet.
Allocation is a day-one decision
The question of who covers overruns has an uncomfortable but clarifying answer: unless a contract says otherwise, the developer does. The contractor covers what the building contract genuinely transfers. The contingency covers what it was sized and preserved to cover. The sponsor covers what it has undertaken to cover. Everything else is the developer’s, and the honest way to run a development is to assume ownership of that residual risk from the first day and structure so that it never becomes existential.
That assumption changes behaviour at every stage. It argues for a building contract read for its exceptions rather than its headline, for a contractor chosen for solidity and not only price, for a contingency defended against the temptation of upgrades, and for treating the monitoring surveyor’s certificates as management information rather than an obstacle course. It also changes the conversation with lenders. A developer who arrives explaining how the structure absorbs an overrun, layer by layer, is describing a project built by someone who has seen budgets fail and planned for it. Lenders fund that developer differently.
The discipline is not pessimism. Most well structured projects never exhaust their contingency, and the undertakings behind it are never called. But the reason they are never called is the same reason they exist: a structure that has already decided who pays does not turn a cost problem into a control problem. The overrun stays what it should be, a number inside the budget, instead of becoming what it becomes in unprepared projects, the event that decides who ends up owning the building.
Montclare does not act as a lender. It structures transactions, prepares the file and coordinates financing with authorised institutions.