What is Overage?
Overage is a potential right to receive future payments in respect of land. The potential right becomes an actual right when the relevant trigger event occurs. Examples of overage situations are:
- Where there is potential for the future grant of planning permission that will increase the value of land
- Remedying a problem that resulted in a sale at a low price (where for example the problem was not as expensive to solve as feared, e.g. remediation of contamination)
- The realisation of development profits where the seller sold for a low price specifically with the intention of sharing in those profits.
- Where there is a better than expected rent review (the sale price having been based on an assumed rent)
- Political reasons or to avoid embarrassment if the land is sold by a public body and the value then shoots up
Trigger events can include:
- Grant of planning permission for change of use or development
- Implementation of planning permission
- Practical completion of development
- Sale or lease of property with the benefit of planning permission
- Sale or lease of completed development
Overage is sometimes described as “clawback”, generally in the public sector. The public sector tend to describe payments constituting a share in the sale proceeds following completion of the development as overage and payments in relation to the increase in value of a property due to a trigger event as clawback.
Overage provisions can be either “positive” or “negative”. “Positive overage” involves the buyer promising to make a further payment to the seller if a particular specified event should occur, whereas “negative overage” involves the seller imposing a mechanism to prevent a particular development or change of use. The seller can then require payment of an additional sum in the future for the release of such mechanism.
Points to be considered when negotiating overage
Whilst sellers and buyers may often agree that overage is to be payable, it is important that the detail of the arrangements is dealt with in the legal documentation. There are a number of points which need to be considered:
- What exactly has to happen to trigger a payment of overage? Should this be the grant of planning permission? If so, outline planning consent or detailed planning permission? Is it the resolution to grant planning permission or the actual grant of permission? Should the period for judicial review challenge have expired first? Other triggers could include implementation of development, completion of the development, disposal of completed development.
- How long does the overage agreement last?
- Will there be more than one bite at the cherry? The seller is potentially at risk if he does not have the right to get payment every time there is an enhancement of value.
- What are the parties’ obligations? It will often be important to put an obligation on the buyer to apply for permission for a minimum size of development and the buyer must keep the seller properly informed.
- How do you calculate the overage payment? This can either be simple or complex. With complex mechanisms, the parties will need to agree exactly what is covered by, for example, “development expenses”.
- How do you secure the payment?
Methods of securing overage payments
There are a number of ways in which overage obligations can be secured, but each method has its own advantages and disadvantages. Some of the more common methods are:
- Bond or guarantee – the buyer provides a third party guarantee as security for the overage payment and if the buyer fails to comply with its obligations, the seller has recourse to the guarantor. However, this can be costly, depends on the continuing financial strength of the guarantor and is not always easy to obtain.
- Charge or mortgage – the seller takes a legal charge over the property following completion and if the overage payment is not made as agreed, the seller can sell the land and take the overage payment out of the proceeds. This is the preferred option where the buyer has no lender.
- Granting a lease including a positive overage covenant – the lease could include provision for the rent to take account of any increase value due to development or change of use or for the tenant to make a lump sum payment. The buyer can be granted an option to purchase the freehold following payment of the overage. However, this method can be costly and the leasehold structure may not suit all situations.
- Granting a lease with restrictions on development – the seller could grant the buyer a long lease of the property including a user clause prohibiting alterations or certain uses, so that if the buyer wishes to redevelop it would need to obtain the seller’s consent and pay the seller for such consent. However, the enforceability of this is uncertain as the tenant has certain statutory rights and the Lands Tribunal has power to modify the covenants.
- Personal obligation – the buyer contracts to make a further payment to the seller should the trigger event occur within the overage period. This is the simplest method, but the burden of the covenant does not generally bind successors in title and this method also depends on the buyer’s continuing financial status.
- Positive covenant and restriction – the buyer agrees to make a further payment to the seller should the trigger event occur within the overage period and also covenants to ensure that any successors in title enter into similar arrangements. The restriction is registered against the buyer’s title on completion of the sale of the property and is released when the overage payment is made or the overage period expires. This is a method that is commonly used in practice, but it can be cumbersome and costly for the buyer to prepare the deed of covenant and there are also registration issues.
- Ransom strip – the seller retains a strip of land next to or across the property being sold, so as to stop the buyer from developing the land unless the seller sells the ransom strip or grants a right of way over it to the buyer in return for payment. This is a simple method, but the buyer may be able to find an alternative access and the existence of the ransom strip may affect the market value of the property. The seller will also have to deal with the usual issues faced by a property owner throughout the overage period.
- Reservation of rights – the seller may retain certain rights over the property being sold in favour of its retained land, forcing the buyer to make an overage payment to the seller in order to develop the property. This is a simple method, but its enforceability is uncertain, the amount of the overage payment is not known and if the seller has to take the matter to court, the damages awarded by the court may be less than the seller may wish for.
- Restrictive covenant – the buyer covenants with the seller not to use the land for certain activities or to build on the land, so the seller can demand a payment for the release of the covenant. This is generally used where there is no short-term possibility of development. However, the seller must retain some land that genuinely benefits from the covenants, not just a ransom strip, and property maintenance issues would arise throughout the overage period. There may also be doubts as to the enforceability of the covenant and the amount payable by the buyer would be unknown. The Lands Tribunal may also discharge or modify a restrictive covenant.
- Right of re-entry – the seller transfers the property to the buyer, but retains a right of re-entry, under which the property will revert to the seller if the overage payment is not made in accordance with the agreed terms. However, the enforceability of such right is uncertain, and this may be unacceptable to lenders.