The concept of overage is relatively straightforward. In essence it is a deferred sum payable in addition to the basic purchase price, but only on the occurrence of a specified event at some point in the future, most commonly in connection with the grant of planning permission for development. However, establishing a mechanism which reflects the parties’ intentions can prove extremely complex.
There is no simple formula or structure which will cover all cases and guarantee that the particular overage obligation will continue, in all circumstances, to be enforceable as intended. Frequently the full implications are not fully contemplated by the parties at the outset, partly as the anticipation of all future eventualities is required. Practical issues and unforeseen circumstances can make an overage agreement potentially unworkable.
Careful deliberation is therefore needed at the very outset of any transaction to avoid scope for argument and expensive litigation at a later stage.
The main considerations are:-
Parties should be clear as to what will trigger the overage payment. They will have conflicting interests, with the seller wishing the trigger event to be when the increase in value actually occurs and the buyer wanting to make payment only once he has actually realised that value. There are a number of potential circumstances which can give rise to overage being payable including: the date of grant of outline or full planning permission; date of receipt of the decision notice; full or partial implementation; practical completion of the development; disposal of the property subject to planning permission; or sale of the first or last unit on the development, where care must be taken in defining what constitutes a “unit”. It is also crucial to establish whether overage is only to be paid once, or on a number of occasions.
Period of overage obligation
The duration of an overage obligation cannot be open-ended and again the parties will have conflicting concerns. If the overage period is too short, the buyer may postpone any action which would trigger the payment obligation until after the expiry of the overage period. However, the period cannot be too long as this is likely to reduce the value of the purchased land and hinder the buyer in the raising of finance.
There are many methods of calculating overage. The starting point will often be the open market value of the land to which a formula is then applied. Overage may be determined, for example, by reference to a percentage of: the increase in value of the land; profit made on the development or such profit if it exceeds a specified amount; or the proceeds realised from the development on sale price of individual units if that exceeds a specified amount. If the profit formula is used, a buyer will want to ensure not only that all relevant development costs are deducted, but also that inflation is taken into account. The seller will wish to make sure that the buyer cannot avoid payment by transferring the land to a connected third party at an undervalue, allowing that party then to sell on for a profit. Whatever formula is used, parties should ensure that the agreement is clear and comprehensive in order to avoid uncertainty.
It is imperative from the seller’s perspective that the overage obligation is protected and that it can be enforced against not only the original buyer, but also against his successors. Without adequate security in place, overage provisions can prove virtually worthless. The fundamental legal problem is that positive covenants are not automatically enforceable against successors as they do not run with the land. A charge is deemed to be the most effective and straightforward method of protecting the overage entitlement, but is seldom acceptable to buyers and lenders. It is more common for an overage agreement to contain an obligation on the buyer to procure a direct covenant from his successor, backed up by a restriction at the Land Registry preventing any dealing with the land without the seller’s consent, which will be given if a covenant has been entered into by the successor. Alternative methods of securing overage include third party guarantees or bonds, ransom strips, rights of re-entry coupled with a notice on the buyer’s title and reservation of rights over the property in favour of the seller’s retained land.
This is by no means an exhaustive list of matters to consider when contemplating an overage arrangement. Overage provisions usually reflect complex arrangements and great care must be exercised so that they are effective. It is unsurprising that an increasing number of disputes, over the manner in which the particular overage arrangement is to operate, are ending up in court. In some cases, the overage structure has been shown to be defective and in others, there is a clear disparity between the parties’ intentions. It is therefore important that the key elements and likely issues are clear right from the start.
Head of Department & Partner
If you require any further information about the issues raised in this article, please contact Simon Catt (firstname.lastname@example.org) or any other member of Goodman Derrick LLP's Real Estate team on 0207 404 0606.
This guide is for general information and should not be relied upon as providing specfic legal advice.
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