What is an overage agreement
15 Feb 2022
An overage agreement (also known as the clawback or uplift agreement) is where a buyer agrees to pay the seller extra money where the value of the site increases in the future.
Who benefits from overage?
The purpose of such an agreement is that sellers will be entitled to a share in the uplift in value following the completion of sale.
This can also benefit buyers as the initial purchase price will be reduced with the proviso that they are committed to paying more if the value of the land increases.
The parties may agree certain deductions from the overage payment such as the buyer’s costs for obtaining the planning permission, the original price of the land and any other costs the buyer may reasonably incur during the planning permission process. The seller must ensure that the buyer does not inflate these costs to avoid or make unnecessary deductions to the overage payment. It is therefore worthwhile for the seller to insist the buyer provide evidence of the costs incurred and to consider capping the costs so that the buyer does not take advantage of the situation.
Types of overage
There are three main types of overage:
Planning overage: this is an uplift payment that is payable once planning permission is obtained as this has caused the value of the land to increase.
Sales overage: this is an uplift payment payable by the developer where revenue generated by the developer exceeds the expected base revenue and agrees to share this with the seller.
Sale at a profit (anti-embarrassment overage): this overage falls due on the buyer who sells undeveloped land at a profit without obtaining planning permission. For example, if the seller sells land to Developer A at a fixed price, and Developer A immediately sells this land to Developer B at a profit without making any further developments to the land the seller is left in an unfortunate position.
The circumstances in which a seller may use an overage agreement
Overage is usually an effective method of agreeing commercial terms where at the time of exchange it is unclear what the land is actually worth.
- New planning permission is granted for further developments on the land
- The land is used for another purpose and planning permission is granted for this reaso
- The construction of houses exceeds a specific number or development is greater than what was originally proposed.
- There is a sales overage where the buyer agrees to pay the seller an uplift payment.
What are the key elements of a planning overage?
Although there is no minimum period for the duration of an overage, parties usually agree a set period of 5-10 years to give a realistic chance of obtaining future planning permission.
What will trigger the payment?
The seller will usually want the overage paid at the earliest opportunity with the buyer trying to delay payment for as long as possible. Traditional trigger dates include grant of planning implementation, first occupation or practical completion of the site.
How much is the payment/ how is it calculated?
Typically, the amount payable will be the percentage of the uplift in value or the difference in open market values of the land before and after obtaining planning permission.
As a rule of thumb, it is imperative that a simple formula is added in the overage agreement so that future beneficiaries may understand how the original parties have agreed the amount payable for the overage. It is also worth having a worked example attached with the agreement to make the calculation easier to follow and to show that the outcome/amount payable is as the parties expect.
What are the key elements of a sales overage?
What triggers the payment?
When drafting the agreement, reporting obligations and disputes provisions should be included to clarify when the overage amount is payable.
Once the sales revenues exceed the base figure the buyer will be required to pay sales overage. This is often paid in stages either quarterly or annually or following a certain number of unit sales.
How is payment calculated?
The calculation of the overage is triggered once the revenue exceeds the agreed base revenue, and the parties may agree that the seller is entitled to a percentage share of the revenue.
What are the key elements of a sales at a profit or anti-embarrassment overage?
How the Seller’s rights may be protected
This form of overage is risky as the developer buyer may decide to immediately (knowing that they are getting a good price) sell the land at a profit without making any developments leaving the seller at a disadvantage.
To avoid such embarrassment, the seller should include provisions in the original sale documentation that require Developer A to pay all or part of the profit it has made to the original seller.
Common Methods of securing overage and protecting the seller’s rights
On completion, a restriction can be registered against the buyer’s title to the land at HMLR which prohibits the buyer from selling the land without the seller’s consent.
The seller can give consent so long as the buyer’s successor entered a direct covenant complying with the overage provisions.
2. Mortgage/ Charge
Following completion, the seller can take a legal charge over the land although an existing lender may be unwilling to approve this if there are existing charges on the land.
The overage payment is secured once the legal redemption date occurs (i.e. planning permission is granted, land is later redeveloped or a revenue threshold is passed). If the payment is not made and the legal redemption date is triggered, the seller can sell the land and recover the overage payment from the proceeds of sale.
Other Methods of securing overage and protecting against the seller’s rights
1. Personal obligation
The simplest and most cost-effective way of securing overage is for the buyer to give a contractual commitment to make a further payment to the seller should a specified event occur.
However, since this is a positive covenant, the burden does not run with the land which essentially means, unless there is a chain of indemnity, the burden does not pass to future buyers of the land.
2. Seller’s Lien
If the overage payment is included within the purchase price, the seller can acquire an equitable or seller’s lien over the land. This occurs when the buyer has not paid the full purchase price on completion of the sale.
The seller can subsequently apply to the court for a declaration that proves the existence of a lien and for an order for sale of the land resulting in the overage payment being taken from the sale proceeds.
3. Ransom Strips
The seller can retain ransom strips around the boundaries of the land which means that until payment is made the seller will have some control over how and when the land is developed.
However, the issue with this is that the buyer can negotiate access over neighbouring land which renders the ransom strips worthless. It may also depreciate the land’s market value thereby reducing the overage payment the seller may receive.
4. Reservation of rights
The seller may retain certain rights over the land which effectively prevents development unless these are released. This gives the seller the upper hand and forces the buyer to make the overage payment before proceeding to develop the land.
Will making a payment release the obligation?
Overages are usually a one-off payment based on the initial singular development of the land. This can however put the seller at a disadvantage as the developer can make a small value development to clear off the overage payment and proceed to make larger developments later. It is therefore imperative that the seller ensures to add a good faith clause in the contract to prevent them from being exploited or there should be a clause stating that there is a minimum provision before overage will take effect, perhaps around 10%. You may also consider multiple triggers within the overage period to avoid a developer avoiding the overage provisions.
For more information, please contact Huseyin Huseyin or Aadhira Nair on 020 8872 3014 or via email: firstname.lastname@example.org