If you are thinking of selling land that may benefit from an increase in value later down the line, or if you are looking to purchase land to carry out activities that may result in an uplift in value, it is essential that you understand overages and how they work in practice. In this article, our commercial property solicitors will guide you through the basics of overage agreements and what property owners and buyers need to know about them.
- What is an overage agreement?
- Benefits of an overage agreement
- Types of overage agreements
- Key terms to include in an overage agreement
- Overage clause loopholes to be aware of
- Overage agreement disputes
What is an overage agreement?
An overage agreement is a type of contract used in some commercial property transactions which is designed to ensure that the seller of a property receives an additional payment from the buyer, known as an overage payment, if certain conditions are met in the future. When the conditions are met, the overage is ‘triggered’ and the additional payment becomes due. The main purpose of an overage agreement is to ensure that the seller is adequately compensated if the value of the property increases after the sale of land.
Benefits of an overage agreement
Overage agreements can provide benefits for both buyers and sellers of land.
If you are selling land, overage agreements will:
- allow you to receive an additional payment for the future development potential or other future uplifts in the value of the land. This means that if the land is developed and its value increases, you will receive a share of the increase in value, rather than just the initial sale price;
- provide a guaranteed further payment if certain conditions are met, such as obtaining planning permission; and
- provide a level of certainty, as the overage payment is agreed in advance, rather than relying on the uncertain process of the land being developed and sold.
If you are buying land, overage agreements will:
- allow you to secure the land for future development without having to pay the full value of the land up front. This can be particularly advantageous if you are uncertain about the potential for future development or the time frame for development; and
- provide a degree of protection, as you can structure the agreement to ensure that you only pay the overage if certain specific conditions are met such as obtaining planning permission.
Types of overage agreements
There are three main types of overage agreements:
The most common type of overage agreement is appropriate where the buyer intends to develop the property in the future and they are triggered in circumstances where the planning position of the property changes.
This type of overage agreement is often used in property transactions where there is a potential for future development. It is a good way for the seller to capitalise on the future development potential of the land, as they will receive additional payments for the increased value of the land as a result of the planning permission. It benefits the buyer too, as they only have to pay the overage if the agreed conditions (i.e. grant of planning permission for a particular development) are met.
Another type of overage is a sales overage, which allows a seller to receive a share of the buyer’s profits where the property is developed and then sold. Sales overages can often be used where a residential development is carried out, and they are triggered on each plot sale.
Overages can also be triggered simply by the sale of a property. Essentially, the seller of a property agrees to receive a percentage of the uplift in value of the property even if the buyer takes no action to improve its value. These types of overage are usually granted for a shorter period and allows a seller to avoid embarrassment in the event that it becomes apparent that the property was not sold for the best value.
Key terms to include in an overage agreement
What is the trigger event?
The trigger event in an overage agreement pinpoints the specific condition that must be met in order for the overage payment to become due. These conditions will be agreed before the agreement is entered into and must be carefully considered by both parties to avoid future dispute. They will generally be tailored to suit the specific circumstances of the transaction.
Common trigger events include:
• the grant of planning permission for the development of the property;
• the implementation of any planning permission the buyer has secured on the property; or
• the sale of the whole or part of the property (before or after any development has been carried out).
How long should the overage period last?
The overage period is the length of time during which the overage payment will become payable by the buyer if a trigger event takes place. The overage will fall away after the expiry of the overage period and the buyer won’t be required to make any overage payments after the expiry even if a trigger event is met.
The overage period can vary depending on the specific circumstances of a transaction, the negotiating positions of each party and the type of overage, but generally they can last anywhere from a few years to a few decades. A buyer will want a shorter overage period in order to reduce the length of time during which it will be responsible for making overage payments, whereas a seller will want a longer period as it provides a greater potential for receiving the overage payment.
How the overage payment will be calculated
The calculation of overage payments can be complex and will typically depend on a range of factors. Usually, the buyer will be required to pay a percentage of the increase in value of the property after the trigger event has taken place and this will be expressed as a mathematic formula which will be set out in the agreement.
The increase in value will either be ascertained by reference to the actual sale price when the property is sold on to a third party, or an independent surveyor will determine the market value of the property on the trigger date based on certain assumptions and disregards. The uplift in value will be the difference between this figure when deducted from either the original purchase price that was paid for the property or the market value. Deductions or costs will also be factored into the calculation, such as costs of obtaining planning permission or the costs of any infrastructure or remediation works required as part of the development.
Additional consideration will need to be had to deal with situations where the property is sold with other land which is not subject to the overage, or if only part of the property is sold.
This formula is a balancing act, and the Seller will need to ensure that the terms are not off-putting to prospective buyers and there is an incentive to develop the land.
Protecting overage payments
Obligations contained in overage agreements do not automatically pass over to new buyers if the property is sold on, so sellers will need to carefully consider how they protect their interest and take legal advice from a commercial property solicitor on the most appropriate method based on their individual case. Some of the options available to the seller are:
- Restrictions and Deeds of Covenant
This is the most common method of protection.
The seller can prevent the registration of a disposal of the property at the Land Registry (which has negative consequences with regard to ownership) if the terms in the overage agreement have not been met. One of these terms is that any future owner of the land must enter into a Deed of Covenant with the seller.
A Deed of Covenant is a binding agreement that will be entered into between the seller and any future owner of the land in the event that the buyer sells the property. This creates a direct contractual relationship between the seller and any subsequent owner of the land even though the subsequent owner was not an original party to the overage agreement. Any failure to pay the overage payment can then be enforced by the seller directly against a subsequent owner.
The seller takes a charge over the property being sold to the buyer. If the overage payment has not been made, the seller will be able to take ownership of the land or could force a sale of the land.
- Ransom Strips
The seller retains a strategically important piece of land that runs along the boundary of the property being sold until the overage payment has been made.
This is a promise by a third party to pay the overage payment in the event that the buyer fails to make the payment itself.
Overage clause loopholes to be aware of
Taking legal advice is essential as there are various loopholes to be aware of. Commercial property lawyers can take steps to mitigate the risk of loopholes arising by carefully drafting and negotiating the agreement.
Common loopholes include:
- A developer obtains planning permission for, or works on, a smaller development which triggers the overage and when they are free of their obligations under the overage they then obtain planning permission, or start work on, a much larger project.
- A developer does not make a concerted effort to promote and/or sell the development during the overage period.
- A buyer avoids the overage by transferring the property to a group company or SPV at a low value. That group company or SPV purchases the property free of the overage and is able to do what it wishes with the property.
Overage agreement disputes
Disputes can arise for a variety of reasons including the amount of overage payment due, unclear trigger events, enforcement issues and non-payment of an overage payment. In each case, it is important to seek legal advice from a commercial property dispute solicitor so you can resolve your dispute as quickly and efficiently as possible.
The first step in the event of any dispute is to try and resolve it through negotiation between the parties. If this is unsuccessful, alternative dispute resolution methods such as mediation or arbitration can be considered. Overage agreements will often state that independent third parties such as surveyors can assist in resolving disputes, for example if it relates to the calculation of the market value of the property.
Parties may have to resort to legal action if the alternative dispute resolution methods do not resolve the dispute. The main remedy available following legal action is damages for breach of contract. Where the buyer has failed to pay the overage payment, the damages would be the amount of the overage payment plus any losses caused by the breach of the buyer’s obligations to pay the overage payment.
Overage agreements can be useful in commercial property transactions, but they are often complex and highly individual to the specific circumstances of the transaction and each parties’ bargaining power. For these reasons, both buyers and sellers can benefit significantly from obtaining legal advice from a commercial property solicitor at the outset so that both buyers and sellers of property can ensure that their interests are incorporated into the agreement.
Whether you are a buyer or a seller of property, we can help negotiate overage agreements on your behalf, ensuring that you benefit from the most favourable terms and we can also ensure that the overage agreement can be enforced in practice.