Overage Agreements – Mind the Gaps!
Overage agreements (also known as claw-back or uplift agreements) are commonly used when land is sold either for development purposes or when land could have development potential at a point in the future.
They have become increasingly popular over the last 20 years. At their basis level overage provisions will provide for one or more additional future payments (in addition to the original purchase price) based on the increase in value following development or planning permission for development. The seller may benefit from the arrangement with a second (and perhaps third and fourth) bite of the cherry.
Overage agreements are notoriously tricky to draft as they are completely bespoke to the transaction in question. They also contain many risk areas for a seller. For that reason it is absolutely vital that such contracts are negotiated by a legal specialist. Gaps and omissions in the drafting of an overage agreement can in the worst case scenario lead to a seller missing out what could potentially thousands of pounds or a developer obtaining planning which ultimately proves to be financially unviable due to the level of overage having to be paid.
So, what does a seller need to look out for?
- The Trigger Event
The trigger event in an overage agreement records at what point in time any overage payment becomes payable by the buyer. A seller will typically want this to be payable as soon as possible. This could be on grant of planning or implementation of planning. However the developer will be looking to pay on sale to ensure they have a cash flow out of which the payment can be made.
Sellers also need to be wary of avoiding traps with trigger events. There have been historic cases of developers deliberately failing to sell the last house on a development plot to avoid triggering an overage payment. For example, in Sparks v Biden  EWHC 1994 (Ch), overage was to be triggered on the sale of the last of a group of newly-developed houses. However, the developer tried to avoid triggering overage by occupying the house himself. On a strict interpretation of the written agreement this appeared to frustrate the overage provisions. Luckily, the court came to the seller’s rescue, holding that the developer had an implied obligation to take positive action to sell the houses. This case serves as a warning to sellers as to the problems which can arise where agreements are not well drafted.
It is also key for a seller to establish within the documentation whether there will only be one trigger event, after which the overage ends, or whether there can be multiple trigger events during the overage period. A single trigger event can allow a buyer to begin with just a small value development on only part of the land so that the overage payment is minimal. This then gives them free reign to develop out the site without any obligation to make further payments. A good faith clause and a minimum overage payment amount can protect the seller against this risk.
A seller also needs to have the protection of reporting obligations from the buyer (such as to provide the buyer with a copy of any planning application, planning consent or sales updates) and a dispute provision allowing for third party determination.
- Duration of the Overage Period
Another key concern for the seller is the length of the overage period. Whilst a buyer will want this to be as short as possible, a seller will want this to be as long as possible. Imagine selling land with a 5 year overage period only to find out that in the sixth year the buyer has secured a planning permission which has increased the value to 10 times the original purchase price.
Typically, an overage period will be linked to a realistic estimate of how long it will take for additional value to be realised, perhaps 5 to 10 years, but the seller should always add a safety net to any estimated time scale. Where bare land is sold which is not yet allocated for any specific development the overage period could be as long as 30 or even 50 years.
- Overage Payment Calculation
Having agreed the length of the overage period and the trigger events, a seller also needs to establish the actual calculation for an overage payment, as these can be structured in many ways. Typically, this will say the seller is entitled to a certain percentage of the difference between market value following the trigger event and market value when the land was initially purchased. These calculations are best kept as simple as possible to reduce the margin of error and the likelihood of dispute.
A buyer will want to agree certain deductions from the overage payment, such as the costs and expenses of obtaining planning permission. A seller should be careful that these are properly defined and appropriately limited to avoid the buyer having the benefit any amount of deductible costs it wishes.
Given that it can be some years before an overage payment is actually made it is also beneficial to a seller to include a worked example with reference to example scenarios and figures so that when the document is read in the future the parties are not left scratching their heads trying to remember what was initially intended by the calculation.
- Securing the Overage
Whilst an overage agreement can run to many pages covering all of the “what-ifs” and “whens” a seller needs to be absolutely certain that any overage payment due will actually be made by the buyer. Without a way of securing the overage payment a buyer could develop the land, sell the plots onwards and disappear into the sunset without ever actually making a payment to the seller.
Perhaps the most “commercially acceptable” way for a seller to secure it’s right to receive overage is with a restriction on the title to the land at Land Registry. This will state that the land cannot be sold without a consent from the original seller. The giving of that consent will be conditional upon the buyer making payment of any overage sums that have become due and a deed of covenant being required from the onwards buyer to comply with the terms of the overage in relation to the rest of the overage period.
Given the many complexities of overage provisions, a seller will need not only the advice of a solicitor, but also of an experienced surveyor. Valuation advice at outset of your negotiations will be key to ensuring that the terms agreed early on in the process work in your favour. In addition, a seller will need advice from a tax specialist due to potential capital gains tax liabilities. With a surveyor, tax advisor and experienced solicitor all working together for the benefit of a seller an overage agreement can provide security for the client that any possible future payments are protected in as far as possible.
These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice.