Drafting overage – a crystal ball would be handy!
There is no doubt that overage is an effective way for a seller to benefit from an increase in the value of land which the seller has previously sold. Overage is a form of deferred consideration which means that the buyer is liable to pay an additional sum to the seller when a “trigger” event occurs at some time in the future, for example, when planning permission is granted for development or on the subsequent sale of the property at a higher price.
Despite being negotiated as part of the deal to purchase (a lower sale price is usually agreed to take account of a future payment) overage agreements are often unpopular with buyers who feel they are being made to pay twice. So it is not surprising that when a trigger event occurs that buyers will scrutinise the wording of the overage provision very carefully to see if there’s a loophole to avoid payment.
An example of what can happen when a trigger event is not precisely drafted is illustrated in the Court of Appeal case of London and Ilford Limited v Sovereign Property Holdings Limited .
London and Ilford (L&I) bought a mixed-use commercial building from Sovereign Property Holdings (Sovereign) for over £7 million, with an additional £750,000 payable under an overage provision within a time limit (overage period). L&I planned to convert the offices into residential with the trigger for payment of overage being prior approval for change of use for a minimum of 60 residential units.
The definition of the "Residential Units" was: "residential dwellings to be comprised in a development at the Property for residential use for sale or lettings”.
Approval for change of use was issued within the overage period but unfortunately for L&I, the units could not be built as there were insufficient fire escape provisions in order to comply with building regulations. As the approval was the trigger event for the payment of overage, Sovereign demanded the sum due and successfully applied to the High Court for an order to that effect.
L&I appealed to the Court of Appeal arguing that the definition of Residential Units “for residential use for sale or lettings" meant that as the units could not be built because of the lack of building regulations, they were not available for sale or letting and therefore the overage was not payable.
A nice try, but unsuccessful; the Court of Appeal pointed out that if L&I wanted the trigger for overage to be dependent on building regulations approval, then they should have included this in the drafting. This left L&I having to pay £750,000 despite being unable to build the units.
So what can be learnt from this expensive lesson? Clearly attention must be given to the drafting of trigger events and their timing; in particular it highlights the danger for a buyer agreeing to pay overage purely on the grant of planning permission (or similar such as change of use) without considering other conditions which may be required. In this case, it would have been more sensible for the buyer to negotiate with the seller that:
- the overage payment was triggered by the implementation of planning permission (as opposed to the grant) so the buyer would have certainty that the development could go ahead, or
- linking overage to the disposal of the residential units so overage was only paid when they were sold (best case scenario for the buyer, but usually resisted by the seller).
Bevan Brittan has considerable expertise in structuring overage provisions; many of our clients, particularly in the public sector are obliged to obtain the best price possible when selling land. With increasing pressure to dispose of surplus assets, imposing overage ensures that sellers can be confident they have not sold at an undervalue, particularly where undeveloped land has development potential.
Overage provisions can be very complex to draft to ensure they are watertight: trigger events have to cover a number of scenarios; the overage period must be realistic; and an effective security mechanism should be included to protect the seller if the buyer defaults or sells on.
Bevan Brittan’s property team can help with all aspects of overage - even without the aid of a crystal ball!
For more information on this topic please contact Rob Harrison, Mark Calverley, David Hobbs or Ian Caplan.