How to navigate an overage agreement
Mithun Rabheru and Bill Bidder explore the various types of overage agreements and their clauses.
An overage agreement is an agreement whereby a purchaser of land agrees to pay the seller an additional sum of money, on top of the original purchase price. The agreement follows the occurrence of a specified event in the future enhances the value of the land. It allows the seller of the land to share in the enhanced value following the sale and so overages are sometimes referred to as a ‘clawback,’ ‘uplift’ or ‘anti-embarrassment’ mechanism in property transactions.
For this reason, overage agreements are popular with sellers of land with development potential. They also enable buyers to purchase land for a lower initial purchase price. However, there are strings attached. The buyer must pay further sums to the seller if the land in question gains value in the future.
The different types of overage agreements
The three main types of overage agreements are as follows:
1. Planning overage
A planning overage is an uplift payment which is payable once planning permission has been obtained and it can lead to the increasing of the land’s value.
Calculating planning overage often begin with including the grant of a planning permission immune from challenge, the implementation of a planning permission and/or the disposal of the land with the benefit of planning permission.
When dealing with planning overages, it is always best to start the process with the implementation of the planning permission, rather than the grant of the planning permission. This avoids a situation where a buyer pays the planning overage following the grant of the planning permission, but then the planning permission is quashed or revoked, leaving the buyer out-of-pocket.
The overage agreement should always include a formula and worked examples, so all parties know how to calculate the overage payable with reference to example scenarios and figures.
The parties may also agree certain deductions from the overage payment, such as the buyer’s costs of obtaining the planning permission, the original price paid for the land, any previous payments of overage which may have already been paid and other costs and expenses which the buyer will incur due to obtaining planning permission and/or paying the overage.
The parties also need to agree whether they require the overage to be a one-off payment. This can be the case when the overage provisions fall away in relation to all of the land (or the part of it which benefits from planning permission) once the payment has been made. Additionally, it can be applicable when the parties require the overage provisions to continue to apply – this is known as a ‘rolling overage.’ Therefore, if a buyer later obtains a more valuable planning permission to the one originally granted, then a further planning overage payment would be payable to the seller.
2. Sales revenue overage
A sales revenue overage is an overage payment that is payable when the buyer develops land for residential purposes, sells the individual residential units, and expects the sales to generate a certain amount of revenue above a base figure. The seller can then share this additional revenue by way of the sales revenue overage.
The trigger for the calculation of a sales revenue overage is most commonly exceeding the agreed base revenue figure. The overage agreement should always include provisions whereby the buyer must inform the seller of how the sales of the individual residential units are progressing, and an obligation for the buyer to inform the seller as soon as possible once the sales revenue exceeds the base revenue figure so the buyer and the seller can start to calculate the overage payable.
It is likely that there will be certain deductions from the calculation. This can include sales revenue from affordable housing units, build cost inflation, plot purchasers’ incentives or extras, the buyer’s sales costs, part exchange properties and other reasonable costs incurred by the buyer. The sales revenue overage is therefore payable on the net sales figure achieved by the buyer after all costs and incentives.
The size of the development will determine when payment should be made, whether it be in stages (such as quarterly or annually) or once the last unit on the development has been sold.
Again, the overage agreement should always include a formula and worked examples, so all parties know how to calculate the overage payable with reference to example scenarios and figures.
With sales revenue overages in particular, it is important to include a provision to address a situation where the overage is payable even if the buyer does not sell the last unit on the development. This is usually done by including a longstop date – if the last unit has not been sold by this date, the unit in question is then given a ‘deemed disposal value,’ and the sales revenue overage is calculated and paid based on its value.
3. Sale at a profit (anti-embarrassment overage)
This overage is payable when a buyer sells undeveloped land at a profit shortly after purchasing it, but without the benefit of planning permission (i.e., the buyer ‘flips’ the land on to another party at a profit). However, this may leave the seller in an embarrassing predicament. Therefore, to avoid such an awkward situation, an overage may be agreed whereby the original buyer agrees to pay all or part of the profit it has made to the original seller.
Key provisions and tips
Now we have identified the most common types of overages and their trigger events, it is important to include a list of ‘permitted disposals.’
The buyer should dispose of the individual units and parts of the land without triggering the payment of any overages, so they can generate revenue and discharge its obligations under any planning agreements. The following should always be included in any list of permitted disposals:
a) the sale of individual units constructed on the land (such as plot sales).
(b) the sale of affordable housing units constructed on the land.
(c) the transfer of any land to any statutory authority or body concerned with planning, drainage, highway, other infrastructure or environmental matters or any utility company concerned with the installation of services on or serving the land.
(d) the transfer of any land to a local authority.
(e) the transfer of any land to a management company.
(f) the transfer of any land to a highway authority for the purposes of adopting the roads and footpaths cycleways and open space to be constructed on the development.
(g) any mortgage or charge of the land.
When drafting overage agreements, one should ensure there is a specific date on which the overage obligations will expire, and include a good-faith and double-counting clause. Such clauses prevent double-counting when there is more than one overage payable, and requires the buyer and seller to act in good faith towards each other in respect of the overage obligations.
Another consideration when drafting overage agreements is whether the seller can assign the benefit of the overage to a third party. If so, then the overage agreement should include a clause whereby the seller must notify the buyer in writing that the seller will be assigning the benefit to a third party. The seller should also be placed under an obligation to provide the third party’s details to the buyer and to enter into a deed of covenant directly with the buyer whereby the third party agrees to observe and perform the obligations on the seller in the overage agreement.
Buyers and sellers should also consider the tax implications of overage payments.
For sellers, if Capital Gains Tax (CGT) is payable on the initial sale, then CGT will most likely also be payable on any overage payments. Sellers should therefore obtain specialist tax advice on how to deal with any capital gains tax payable on overage payments and whether such tax can be deferred until the overage payments have been received by the seller.
For buyers, Stamp Duty Land Tax (SDLT) will be payable on any overage payments and if VAT was payable on the initial purchase price, then VAT will most likely also be payable on any overage payments. Buyers may apply to HMRC to defer the payment of SDLT on any overage payments until the overage payable has been calculated and paid.
The buyer will need to make a formal application to HMRC when paying the SDLT on the initial purchase price and it is usually the buyer’s solicitor that does this. It may also be agreed between the parties that the additional SDLT payable by the buyer may be deducted from any overage payments. In such circumstances, the formula and worked examples within the overage agreement should refer to this. Again, it is important for buyers to obtain specialist tax advice on such matters.
How do you protect the obligation to pay the overage?
The following methods can be used to make the obligation to pay the overage payments enforceable against all owners of the land (including future owners of the land):
· The seller can take a legal charge (mortgage) over the land. Where the buyer needs to mortgage the land to a bank in order to buy the land or develop it and the buyer’s lender agrees to the seller taking a legal charge in order to protect the overage obligations then the seller will receive a second legal charge. However, some lenders will not consent to the grant of a second legal charge in which case this may not be a practical option.
· The seller can retain ransom strips around the boundaries of the land sold, giving the buyer the option to purchase the ransom strips on payment of the overage, if and when it falls due. This means until such time as the overage is paid to the seller, the seller retains some land surrounding the development and can therefore control (to a certain extent) the land being developed (e.g., by controlling access to the development).
· A restriction can be placed in the register of the buyer’s title to the land at the Land Registry, prohibiting the buyer from selling it without the seller’s consent. It can only be granted upon payment of the overage or the new buyer entering into a deed of covenant to comply with the terms of the overage agreement. This is the most common and preferred method of securing the overage obligations. If you use this method then you need to ensure there are provisions in the overage agreement to deal with the removal of any such restrictions promptly following the payment of all overages/the expiry of the overage period.
On a final note, as overage payments are a complicated subject, it is always best to include a disputes provision in the documentation in the event the parties cannot agree on the amount of overage due.
Mithun Rabheru is a senior solicitor at IBB Law. Bill Bidder is a consultant at IBB Law ibblaw.co.uk