The role of overage in protecting long-term value – A technical focus

Getting started

A landowner wishes to sell their property but is unsure whether the sale price is appropriate.  Overage is a mechanism by which the landowner may receive more money in the future if a certain event (or events) occur within a specified timeframe.  Overage is often also referred to as “clawback” or “development profit”.

Types of Overage

If the landowner is, for example, a charity or public authority it will not wish to attract criticism for selling its assets at an undervalue and as a result will want to include overage provisions in the sale documentation to ensure that if the land sold off becomes more valuable in the future the seller will be entitled to a share in the increase in value.  Such overage provisions are commonly referred to as “anti-embarrassment” clauses.

The seller may agree to sell their land to a buyer/developer who will then apply for planning permission to develop the land.  At the time the land is sold the parties may not know what planning permission might be achieved.  As a result the seller and the buyer include, in their documents, provisions that provide a mechanism by which the sale price and overage are calculated.

When is overage payable?

Payment of overage could be triggered in any number of situations, e.g.

• sale of land with the benefit of planning permission for development
• when planning permission is implemented

If the buyer applies for planning permission but is refused, will the buyer have an obligation to pursue an appeal or lodge a fresh application for development?  The overage documents may say that if in the opinion of a barrister an appeal is likely to be successful the buyer will be required to appeal the refusal to grant planning consent.

How much?

The seller may wish to ensure that the value of the buyer/developer’s proposed scheme meets a minimum threshold e.g. the application for planning permission must be for a minimum number of houses or flats to be built on the relevant land.

The seller and the buyer may agree that, for example, overage is payable at the rate of X% if consent is obtained for a certain number of units and at Y% in excess of that number.  The seller may also be entitled to overage if the buyer achieves sales in excess of £x.

The buyer/developer will incur costs in making his planning application, including legal and surveyor’s costs, architect’s fees and other expenses.  The seller and the buyer will need to agree if the buyer is allowed to deduct from any profit he makes on the development those costs before overage is calculated.  If the overage period (as to which please see below) is “long” the seller and the buyer may wish to take into account land price inflation.

The sale documents may need to provide for the buyer to be put under an obligation to keep the seller informed of progress; e.g.

• with the making of his planning application;
• the progress in marketing and selling the flats/houses

and also require the buyer to keep a proper record of expenditure, to help facilitate the calculation of overage.

How long does the seller have to wait?

As a rule of thumb, where the seller wishes to provide for “anti-embarrassment” the period will be five years.

Up to ten years might apply where the seller envisages the buyer will apply for planning permission for development.

If it is highly unlikely that the land cannot be developed now or at any time soon then the overage period may well extend to 25 years.

It is possible that more than one trigger event within the overage period may arise e.g. the buyer obtains fresh, more valuable planning permissions for development.  Is the seller entitled to benefit from that?  If so, the sale documentation will need to provide for this.

Who pays?

The sale documentation will need to make clear who is responsible for paying overage.  In a simple, straight forward case (if there is such a thing) then it will be the buyer/developer who pays.

What happens if the buyer developer sells on to another developer, who in turn intends to apply for planning consent to develop?

To secure payment of overage there are a number of ways in which the seller can try to secure payment, but none is foolproof.

The most common method of securing payment is to register a restriction on the buyer/developer’s title that provides that a new owner cannot be registered as such without, say the consent of the seller or a certificate being provided by the seller’s lawyer addressed to Land Registry to confirm there has been compliance with the terms of the original sale documentation.  This is likely to require the new owner to sign a document (deed of covenant) to confirm that the new owner will comply with the terms of the overage obligations of the original sale documents.

Other ways to enforce compliance include a buyer signing a mortgage in favour of the seller to be secured on the relevant land (with right for the seller to call in the mortgage if the buyer fails to pay).  Problems can arise here if the buyer/developer, itself, is raising finance from a lender, who will require security too – the lender will wish to be first in line to be paid.  It may be possible for the lender to agree the seller can have a first charge over a (small) part of the development site.

Heads of terms

The seller and the buyer are recommended to agree, through their surveyors and other advisers, comprehensive heads of terms for a sale, to include detailed provisions around overage.

In addition, the seller and buyer should agree (a) sample overage calculation(s) to try to avoid misunderstanding later.

The seller and the buyer may take the view that the cost of negotiating the overage documentation outweighs the benefit the parties will achieve – a buyer may be better advised to pay a little more for the relevant land and the parties do away with overage clauses.

Does overage have to be paid?

The drafting of the overage documents will need to be carefully checked.  Do the words cover the obligation to pay overage? e.g;

• The overage period is 5 years; planning permission for development is secured after 4 years 6 months, but the buyer does nothing until after the expiry of the overage period. If the drafting provides that overage is payable on a sale of the property or on implementation of the permission, then no overage is payable.
• Are the words that describe how the overage payment is calculated too complicated? A court may not be willing to remedy the defect.
• Is payment of overage triggered by a resolution to grant planning permission or when consent is actually is granted?

Tax

If an overage payment is made the seller may need to make a return to HM Custom & Excise in respect of capital gains tax.  Similarly, a return to HM Customs & Excise may need to be made by the buyer in respect of stamp duty land tax payable as a result of the buyer making the overage payment to the seller, in addition to the duty that was paid when the land was originally brought.

Conclusion

Drafting overage clauses is not straight forward, the seller and their advisers should try to think through all the ways in which payment of overage can be avoided.

How we can help

If you’re dealing with the sale of land or need guidance on negotiating or enforcing overage provisions, our commercial real estate team has the expertise to support you. Please get in touch to find out how we can help.