Overage agreements: careful management
Agreeing a formula
12 June 2015
Overage agreements are complicated to calculate and need careful management to ensure their security, cautions Max Marrison
The inclusion of overage provisions in property contracts continues to be a popular way to protect the interests of the seller. Commercial agents negotiating deals use overage as a means to protect their clients when the true value of land is not ascertainable or cannot be realised on the sale. It is often used by local authorities, public sector bodies and charities that have a responsibility to ensure assets are not sold too cheaply.
An overage obligation is a contractual promise by a buyer to make an additional payment to a seller, which represents a share of the increased value of land after the occurrence of an agreed trigger event during a set period of time. The terms 'clawback', 'anti-turning', 'anti-embarrassment', 'uplift' or 'kicker' clauses are used interchangeably, but essentially they all mean the same.
These trigger events can include the following:
- planning permission is obtained for development or change of use
- implementation of planning permission
- practical completion of a development
- disposal of property with the benefit of planning permission
- disposal of a completed development
- disposal of land at an increased price within a fixed time period.
After careful consideration, a decision should be taken on whether overage is to apply on more than one occasion. A buyer will not want to make an additional payment if the grant of planning permission is unsatisfactory or subject to judicial review, or where the buyer may decide not to implement the permission.
A seller must also consider when the liability arises for a buyer to make the additional payment. It may be inappropriate to insist on overage to be payable on the grant of planning permission or the implementation of a new development if the purchaser does not have the financial resources to comply at that stage. It is wiser to request the payment be made on the sale or letting of a specified number of units.
Buyers will often attempt to avoid paying overage. A good illustration is the 2010 case of Renewal Leeds Ltd v Lowry Properties Ltd. The contract specified an overage payment was due on a development if the total sales revenue exceeded £7.4m on the trigger of the final sale of a completed residential unit.
Lowry Properties obtained planning permission and built 84 houses, but only sold 80 of them. The last 4 were advertised at more than 126% of the market value, yet despite an offer from Renewal Leeds to buy the houses at the inflated price, Lowry Properties declined to sell.
The property contract contained no obligation on Lowry to build or sell the units, but fortunately for Renewal Leeds, the court was prepared to imply a term that if development commenced, the units would be completed and sold.
This case highlights the importance of drafting clear contracts and it is recommended that overage provisions always contain a 'good faith' clause.
The formula for calculating the overage payment can be complex. It may be a fixed sum, a percentage of the increased value of the land with or without planning permission, or a share of the sale price, less base value and development costs (including the Community Infrastructure Levy).
Overage is a personal obligation on the buyer, triggered by the occurrence of a particular event during an agreed period
In recent years, the courts have been kept busy settling disputes relating to the construction and interpretation of the overage formulae. Again, legal drafting must be clear and record the intentions of both parties. We would always recommend that appropriate valuation advice is obtained to support this process and the contract contains a worked example.
The length of the overage period must also be considered carefully. If it is too short, the buyer will simply 'land bank' the property until expiry. If the period is too long, it will effectively sterilise the land and make it less attractive to potential purchasers, which could ultimately have a negative effect on the purchase price.
Protecting your agreement
Security for the overage payment is a very important issue and must be dealt with at the outset of a transaction, when negotiating heads of terms.
Overage is a personal obligation on the buyer, triggered by the occurrence of a particular event during an agreed period. The burden of the contractual promise does not generally bind the buyer's successors in title, so the prospective purchaser's current financial standing must be considered, along with their likely ability to make overage payments in the future.
The buyer's economic prospects might change and in the event of insolvency, the seller could end up ranking as an unsecured creditor.
Ideally, a seller would look to secure the overage payment by taking a first legal charge over the land. If the payment is then not made on the due date, the land can be sold and the money recovered from the sale proceeds.
A legal charge is a very effective mechanism although there are, of course, drawbacks. Most significantly, it is usually unacceptable to any lender providing finance for the proposed development. In the unlikely event that a bank agrees to the seller taking a legal charge over the land, it will insist on a deed of priority being entered into, to restrict the amount secured in favour of the seller.
Security for the overage payment is a very important issue and must be dealt with at the outset of a transaction, when negotiating heads of terms
There are numerous other ways to secure an additional payment, such as a third party guarantee. The downside with this arrangement is that a guarantor's financial standing could diminish during the overage period and may not constitute adequate security in the long run. Bank bonds are a less common option because they are very expensive to obtain and unsuitable in situations where the potential amount of overage is unknown.
Overage can be secured by what is known as an equitable lien over the property. Where the overage payment is defined as forming part of the purchase price, an equitable lien will arise on exchange of contracts and enables the seller to apply for a court order to sell the property and receive the payment from the proceeds. To be effective, the seller must lodge a notice of the lien before the buyer's transfer is registered.
Like the legal charge, a seller's lien is unacceptable to funders and when acting for a buyer we always include a provision in the contract that states the seller is not entitled to any lien over the property.
Overage can also be secured by indirect means, such as reserving a right over the land, retaining a ransom strip or by imposing restrictive covenants that dictate what kind of development can take place. However, there is a danger in relying on such implicit methods. For example, there is always the possibility that a Lands Tribunal may seek to discharge or modify a restrictive covenant and a ransom strip might not work if a buyer/developer is able to find an alternative access.
The most common means of securing overage and enforcing provisions against the buyer's successors in title is by way of a deed of covenant and restriction. Using this method, a restriction is entered on the registered title that states no disposition is to be registered by the Land Registry without the seller's consent and this will only be given if the disponee enters into a deed of covenant agreeing to comply with the overage provisions in the original contract.
In summary, overage can be incredibly complex and take considerable time to negotiate. The impact on potential sales must be considered and it should not be seen as an easy option if the seller is unsure the purchase price represents the market value of the land.
Provisions should be negotiated by suitably experienced solicitors, with input from surveyors' specialist valuation advice. When agreeing terms and the means by which the overage payment is to be calculated, it is important the buyer is motivated to develop land. If the seller is too greedy, the purchaser will simply delay work on the site for the duration of the overage period.
Consideration must also be given to the management of overage provisions in the contract. A seller should monitor what happens to the property and not rely entirely on the buyer to provide information. This can be especially difficult when the transaction has been completed and/or employees within the organisation responsible for negotiating the overage move on to pastures new.
Max Marrison is Head of Commercial Property at Taylor & Emmet LLP
Related competencies include: Contract practice
This feature is taken from the RICS Property journal (May/June 2015)