What is overage?
There is no generally accepted definition of overage. Rather, it is a term used to describe a situation where a seller, in certain circumstances, is entitled to share in an increase in the value of land which is realised post completion of the sale.
Overage (or clawback or uplift as it is sometimes called) is becoming an increasingly common (and often complex) feature of development land sales and that is the context in which it is considered in this note.
Types of overage
There are various types of overage including:
- Planning overage – an example of this is when a farmer sells land to a developer at agricultural use value with an obligation of the developer to pay to the farmer a further sum of money if and when the developer achieves planning permission which increases the value of such land. Another example is when a developer acquires for a fixed sum land that already benefits from planning permission and agrees to pay a further sum if, within a prescribed time frame, the developer obtains a different planning permission which further increases the value of such land.
- Plot sales overage – this is where a developer acquires land for residential development for a fixed sum and agrees to pay the landowner a further sum if the aggregate revenue realised from the residential plot sales exceeds a certain threshold figure.
- Profit (or “turn”) overage – this is where a developer chooses not to develop out a site but to sell it on quickly after acquisition at a price higher than he paid for it but is obliged to pay on completion of the second sale a further sum to the original seller.
The amount of the actual overage payment is a commercial term to be agreed. It may be a fixed sum, or it may be a % figure based on, for example, the increase in the value of the land attributable to the grant of planning permission or the amount by which the aggregate sales revenue exceeds the threshold figure.
Why use overage agreements in the context of development land sales?
From a developer’s perspective, overage agreements help to manage risk and cash flow as the developer is not obliged to pay the extra money unless and until the additional value triggering the overage is actually realised.
From a landowner’s perspective, overage agreements are a useful tool by which to ensure that the landowner receives the best price for the land. A landowner may be more willing to sell his land if he is entitled to share in a future increase in its value. Overage agreements are particularly useful if the landowner is, for example, a local authority or a charity obliged by constitution to achieve “best consideration”.
Terms of the overage
The commercial terms of the overage agreement (for example the nature and amount of the payment, the duration of the agreement etc) will be a matter for negotiation and agreement between the developer and the landowner (usually with the advice of their land agent). It is then for the solicitors to translate and enshrine those agreed commercial terms into a legal binding agreement which properly reflects the intentions of the parties.
However, the devil is very much in the detail when it comes to overage agreement drafting and there are numerous traps for the unwary. In order not to fall into one of those traps, it is important to instruct a solicitor with specific experience in drafting and negotiating complex overage agreements and who understands current market practice.
It is usual for an overage payment to be calculated by reference to a mathematical formula. Extreme care needs to be taken with the formula to ensure that it produces the right result. Two formulae can look very similar but produce startingly different results! For this reason, it’s useful to include in the agreement a worked example of the formula to demonstrate how the parties anticipate it working. This will not just aide future understanding but may well help to avoid or settle potential disputes.
How can the overage agreement be protected?
From a landowner’s perspective, a beautifully drafted overage agreement can be virtually worthless unless it is property protected. Because the obligation to pay overage is a positive obligation it will not be binding on future owners. Therefore, it is essential that the agreement is protected by a mechanism agreed with the developer. There are various ways in which an overage agreement can potentially be protected, but they vary in their effectiveness depending on the particular circumstances and they find varying degrees of favour with developers. They include:
- Taking a legal charge over the land
- A deed of covenant and restriction on title regime
- Restrictive covenants
- Bank bond/ security deposit/ parent company guarantee
Overage agreements and their associated security mechanisms can be very complex and require specialist legal advice. If you are considering entering into a new overage agreement or varying an existing overage agreement, please give Claire Waring a call on 07867 393 496.