What is overage?
Overage is the term used to describe a situation, in the context of a property transaction, where the seller may be entitled to receive additional consideration from the buyer after completion if a specified condition is satisfied. Overage is sometimes described as “clawback” in relation to property transactions involving the public sector but the two phrases are interchangeable.
A buyer is normally required to enter into an obligation to pay overage where there is a reasonable expectation that the value of the land will increase in the future due to a range of factors that are discussed below. Many sellers such as public-sector bodies and charities are under an obligation to sell at the best consideration that can reasonably be obtained and overage provisions can be included as “anti-embarrassment” protection for this reason.
Types of overage and trigger events
Overage obligations can either be described as positive or negative in character.
“Positive overage” involves the buyer giving an express covenant to make a further payment to the seller if a particular specified event should occur (such as redevelopment of the property or a sales revenue threshold being exceeded).
“Negative overage” involves the seller imposing some form of restriction that prevents redevelopment or change of use of the property. The seller can then require payment of an additional sum at a future date in return for providing a release from such restrictions.
A positive overage obligation will require the buyer to make a further payment to the seller which normally equates to a share of the increased value of the property after the occurrence of an agreed trigger event. Examples of trigger events include:
- The grant or implementation of a new planning permission permitting the development or change of use of the property
- The grant or implementation of a new planning permission which supercedes an existing one and makes the property more valuable by, for example, increasing the number of units permitted on the property
- A disposal of the property by the buyer at a higher price within a fixed time period after the initial purchase.
- The revenue generated by a disposal of the completed development exceeding an agreed threshold.
Overage terms
Overage provisions are often complex due to their very nature but some headline points that parties should consider when negotiating terms include:
- How will payment of overage be triggered? (see above for examples)
- How long should the overage apply for?
- Should the overage provisions apply more than once e.g. is overage calculated each time a new planning permission is granted?
- What are the parties’ obligations? A seller will want to ensure that a buyer is obliged to maximise any potential overage payment.
- How is the overage calculated? Overage calculation provisions often involve some very complicated drafting and careful consideration needs to be given to points such as valuation of the property and what deductions the buyer is permitted to make. It is always advisable to include worked examples to reduce the risk of ambiguity and costly litigation further down the line.
Securing overage payments
A seller will want to ensure that it has some form of security for any potential overage payments and there are several different forms of security. Some of the more common methods are:
- Positive covenant and restriction – This is the form of security that is most commonly used in practice. The buyer’s obligations to make the overage payments are secured by a restriction on the title to the property which prohibits the disposal of the property (or any part) unless the provisions of the overage agreement have been complied with.
- Restrictive covenant – In this scenario the seller imposes a covenant on the property not to use the land for certain activities or to build on the land and can therefore demand an overage payment to release the covenant. It is important to note that the seller must retain some land that genuinely benefits from the covenant otherwise it will not be enforceable. Furthermore, the buyer could apply to the Lands Tribunal for a discharge or modification of the restrictive covenant.
- Charge or mortgage – The seller takes a legal charge over the property following completion. If the buyer fails to make the overage payment as agreed, then the seller can dispose of the property and recover the overage payment out of the proceeds. This is often the preferred option for sellers but may not be possible where the buyer has a funder who will require a first legal charge over the property.
- Bond or guarantee – A third party, such as a parent company, will provide a guarantee to the buyer as security for the overage payment. If the buyer fails to make the overage payment as agreed, then the seller has recourse to the guarantor. This is often used where the buyer is a shell SPV and of a low covenant strength. However, the effectiveness of this form of security is dependent on the continuing financial strength of the third party.
- Ransom strip – This operates in a similar fashion to a restrictive covenant in that the seller retains a strip of land adjoining or across the property which prohibits the buyer from developing the land unless the seller transfers the ransom strip or grants suitable rights over it in return for an overage payment.
From a buyer’s point of view it must ensure that, whatever form of security is utilised, it does not prohibit or delay the buyer from carrying out the development or disposals of the completed development.
Comment
As you will appreciate from this high level summary, overage agreements are very complicated documents. There is a considerable body of case law which mainly arises from the terms of the agreement being ambiguous. As the saying goes, “the devil is in the detail” and as such careful thought needs to be given to the terms of the agreement both at the heads of terms and drafting stages.