What is an Overage Agreement?
Overage agreements are becoming increasingly popular and can be attractive to a seller. It may also assist a buyer, by buying the land or property at a lower initial price, but what is an overage agreement?
An overage is an agreement, also known as claw-back or uplift, and is an agreement that the buyer will make a payment or payments in addition to the initial purchase price, if certain conditions are satisfied. A prime example is when land is sold to building developers. However, it is not exclusive to these transactions. An overage provision may be included in the agreement to sell a pony paddock or residential house with a large garden, or adjoining field. The type of property, circumstances and whether a mortgage lender will be involved, all need to be considered. Whatever the transaction, the size of land or value involved, overage provisions should be discussed at an early stage to ensure there are no delays or misunderstandings.
No two transactions are the same, and what may be suitable and reasonable in one sale contract or option agreement, may not be appropriate for another.
Although not intended to be an exhaustive list, initial matters to consider are as follows:-
- Duration - how long the provisions are to last. This can depend on the intentions for the property. Whilst a seller may wish to include a 30-year overage this may affect future sales of the property and 5-10 years may be more reasonable for both parties. For example, if the chance of obtaining planning permission is slim then a longer provision will be more attractive to a seller however, if the land is being sold to a developer, then a shorter overage may be more appropriate.
- Triggers - what will trigger the payments or payment. The granting of planning permission? The commencement of work after the granting of planning permission? The sale of the property? The sale of the first or last house on a development? What development and/ or disposals are allowed without triggering a payment, eg a building for agricultural use only, extensions to a farmhouse or, in respect of disposals, obtaining a mortgage or granting a short term lease.
A buyer needs to ensure there will not be a cashflow issue, they also need to consider the planning permission being challenged or the development being incapable of being built even though planning permission has been granted. In the case of London & Ilford Ltd v Sovereign Property Holdings Ltd (2018) whilst permission was obtained, construction would contravene the building regulations because of incompatibility with fire escape provisions.
From a seller's point of view, they need to be wary of circumstances which could give rise to the buyer avoiding payment, such as the trigger event being the sale of the last house on a development. An element of good faith may be appropriate in the agreement.
- How many triggers. Will the overage end after the first payment or is a payment to be made after each trigger event during the overage period? The buyer would wish for the former to be agreed and this may be reasonable in the circumstances. However, consider the landowner who has sold to a developer and their point of view on the following facts: - the trigger event is the granting of a planning permission, a developer applies for 10 houses and obtains permission, makes the overage payment, and is discharged from the overage provisions. The developer then, immediately afterwards applies and obtains permission for a further 40 houses.
- How much will the overage payment be. Typically, this will be a percentage of the uplift in the market value of the property, or the difference between price of the acquisition and subsequent disposal. The actual percentage will depend on the circumstances and the buyer will incur costs in obtaining planning permission, can these costs be deducted? These points should be considered together, otherwise a seller may end up with a greater profit than the buyer.
- How to secure the payment or payments. It is important for a seller to secure the overage and, other than a permitted disposal, ensure that the overage provisions will run with the land and apply to any future buyers. Usually, a restriction will be imposed on the title to the land, so that no future dealings can be registered at the Land Registry without the consent of the seller. Occasionally, the seller requires a legal charge over the land however, this can be impractical and can cause problems should the buyer wish to raise finance from a bank.
If you would like to discuss any of the above, or require further information please get in touch with a member of our commercial property team.