Keeping Overage Agreements Under Control

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Keeping Overage Agreements Under Control

An overage agreement is a contract which allows a seller to share in an increase in a property's value that is realised after the property has been sold.

It has long been a tactic of sellers of development sites to seek overage provisions in sale agreements, either as an anti-embarrassment measure to ensure that with hindsight the site wasn't sold too cheaply or to simply try and eke as much value as possible out of a deal. Such arrangements are particularly prevalent in the sale of housing sites, where at the point of sale there may be uncertainties as to the volume or disposal value of the residential plots to be constructed on the land.

Overage agreements are by their nature often complicated documents with the parties in essence having to engage in some 'crystal ball gazing' to try to predict the future and make allowances for a number of potential different scenarios. One important point to consider in entering into such an agreement is the issue of the impact of the overage obligations on the buyer's successors in title.

From the seller's point of view there will be a desire to include 'anti-avoidance' protection in the agreement. The seller will want to ensure that successors in title are bound by the overage provisions to ensure that the buyer cannot simply side step the obligation to pay overage by disposing of the land to a third party before the overage liability has been triggered. With that in mind, a well advised seller will usually insist that the liability will subsist for a fixed period of a number of years and will pass from one buyer to another for multiple disposals during that period rather than simply biting 'once and for all' on the first sale.

It is hard for a buyer to argue against the merits of the above given the potential for overage payments to otherwise be easily avoided. However, a buyer must ensure that the seller does not adopt a 'sledgehammer to crack a nut' mentality and prejudice the buyer's ability to develop the site and/or to sell plots to end users by imposing overage liabilities on parties who should not be bound by them.

A well advised buyer should ensure that the overage provisions do not apply to 'permitted disposals'. Such disposals would commonly include purchasers or tenants of completed commercial or residential units, transfers to statutory undertakers of sites for apparatus such as electricity sub-stations or water pumping stations, transfers of land for public amenity purposes pursuant to planning agreements and transfers of land for public highway purposes. In each of those cases the recipient of the land in question will not wish to accept any liability for overage obligations arising out of the developer's initial acquisition of the site. Indeed, the failure to negotiate an allowance for such permitted disposals could ultimately leave a developer with unsellable assets as, for instance, potential buyers of residential units would be unlikely to wish to purchase (and may be unable to obtain mortgage finance in respect of the same) a house burdened by potential future overage payments.

The recent case of Burrows Investments Ltd v. Ward Homes Ltd highlighted the need to ensure that even where the principle of permitted disposals has been agreed, the parties must still define what constitutes a permitted disposal very carefully. In that case the concept of permitted disposals was defined in the contract as including the disposal of one or more residential units (whether to an individual private purchaser or a third party investor) in the open market at arm's length and also included a transfer/dedication/lease of land for sub-stations, public open spaces, roads, footpaths or other social/community purposes.

As part of the obligations linked to the planning permission for the residential development of the property, Ward Homes were required to transfer five units of affordable housing to a private registered provider of social housing. Ward Homes duly transferred the five houses on the basis that the social housing provider took them free of the overage provisions as a permitted disposal. Burrows Investments disagreed with that interpretation of the contract and instituted legal proceedings to claim damages. Ultimately, the judge sided with Ward Homes and dismissed the claim on the grounds that (a) the disposal was for 'other social/community purposes' and therefore fell within the contractual definition of a permitted disposal and (b) an award of damages would not have been appropriate because the revenue realised by the development would not have triggered an overage payment in any event.

The case underlines the need for the parties to consider all eventualities and for contractual provisions to be drafted as clearly as possible. The contract in this case did not specifically address how a disposal of affordable housing to a social housing provider was to be treated and so the parties ended up in court when their differences as to the interpretation of the contract could not otherwise be settled. The parties could have been saved from the time, trouble and expense of a court case if the contract had been more comprehensively worded.

In conclusion, when agreeing to be bound by overage obligations a buyer of land must ensure that those obligations are not so onerous as to prejudice the future realisation of development profits. Furthermore, as is generally the case with legal agreements, the more comprehensive and clear the document is, the less room there is for disagreement. It is imperative that the parties and their legal advisers put in place overage provisions which are comprehensive, clear and contain appropriate limitations. To do otherwise is to run the risk of potentially blighting a development site and/or incurring the costs of litigation to put things right.

To discuss this, or any other real estate commercial issue please do not hesitate to contact the team.

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