What is overage?
Overage is additional consideration payable by the buyer on the sale of a property if and when a specified future event occurs. The amount payable usually represents a proportion of the increase in value of the property since the date of the sale. Overage is sometimes referred to as "clawback", but the terms are generally interchangeable. Overage provisions can be documented in the property sale contract or transfer, or alternatively in a separate overage deed.
Overage is often used in commercial transactions where the piece of land being acquired has the potential for development which would increase the value of the land, but at the time of the sale that potential is merely speculative. For example, an overage obligation may require the buyer to pay a certain percentage of the increased value of land on the grant of planning permission or a percentage of any subsequent sale of a completed development.
The use of overage in this way can provide comfort to a seller that they will get a share of any uplift in value if the development potential of the property is realised further down the line. On the other hand, overage enables the buyer to acquire the site at its current market value, rather than overpaying based on any speculative future development which may never happen.
There are a number of important matters both parties should consider before entering into an overage agreement.
Is overage appropriate?
Overage is best used where the land being sold has realistic potential for development in the medium to long term but is not ready now. If there is little or no prospect of future development then there won't be much value in negotiating overage provisions, particularly as these are often very complicated and therefore expensive and time consuming to document.
If the buyer intends to carry out development immediately or reasonably soon after purchasing the land, overage is unlikely to be appropriate. In such a scenario the buyer is more likely to enter into an option agreement or conditional contract with the seller, with the land purchase being completed after planning permission has been obtained. This allows the seller to receive full value for the land (with the benefit of the planning permission) at the time of the sale, rather than waiting for an uncertain future payment, and the buyer benefits from a certain purchase price.
Triggers
When agreeing overage provisions, it is vital to be absolutely clear what will trigger the overage payment. This can often be the subject of intense negotiation. To use the planning example, a buyer is unlikely to want to pay overage immediately on the grant of a planning permission. This is because they will not at that stage have certainty the development will proceed and any potential future income from the development will be realised. Furthermore, the grant of planning in and of itself is unlikely to realise any funds for the buyer to pay the overage, so it may have to go into its own pocket. Meanwhile, the seller will be keen to receive any overage payments as soon as possible and so will push for overage to be triggered early in the process.
There are many options available to the parties when deciding how and when overage will be triggered. Which one is most appropriate will depend on the nature and commercial terms of the transaction and the bargaining strength of the parties.
Options include overage becoming payable:
- on the grant of a planning permission
- on the implementation of a planning permission
- on a sale by the buyer for a higher price than that for which they acquired the property (known as "turn overage")
- (in the case of a multi-unit development) when a certain number of units have been sold
There are likely to be issues if the triggers are not clearly defined. For example, what happens where the trigger for overage is the sale of the last of a set of newly constructed homes, but the buyer deliberately doesn't sell the last one and rents it out instead? This scenario was considered by the courts and luckily for the seller, a term was implied into the contract obliging the buyer to sell the last property. It would have been better for all involved if this scenario had been covered in the contract.
What happens if the grant of planning permission is the only trigger for overage, planning permission is granted but the buyer cannot carry out the development because it is unable to obtain building regulations approval? Tough luck for the buyer, according to the courts. They should have extended the definition of trigger event in the contract to include obtaining building regulations approval, or alternatively included some catch all wording such as obtaining "all other consents necessary to carry out the development".
These are just two examples which highlight the dangers of not having clearly defined triggers within overage provisions.
Securing payments and duration of overage period
The beneficiary of an overage obligation will want to ensure they have adequate security for any future overage payment/s, and in particular recourse to the land itself should the buyer become insolvent. The best security is a legal charge secured on the property, but buyers are often resistant to this, particularly if they have a mortgage.
An alternative and more common method of securing overage is to enter a restriction on the title to the property preventing the buyer from disposing of it without the seller's consent. This is typically coupled with an obligation on the buyer not to sell the property without first procuring that their buyer enters into an agreement with the original seller to take the property subject to the overage provisions (this may be subject to certain exemptions – see below).
It is unlikely that a buyer will agree to encumber the property with an overage obligation that has no end-date. It is, therefore, normal practice for a time limit to be set after which the overage will fall away and the buyer will be free to deal with the property. The duration of the overage period will depend on the nature of the transaction but can often last many years, or even decades.
Calculation of overage and deductions
The method of calculating the amount of overage payable will be the subject of commercial negotiations between the parties. The formulae involved can be hugely complex and specialist valuation advice should always be sought.
Common approaches in the scenario of planning overage are:
- A percentage of the increase in the value of the property following grant or implementation of a planning permission.
- A percentage of the profit or sales revenue the buyer achieves on the sale of units in a development.
- A fixed sum payable on the sale of each unit in a development (perhaps up to a certain cap).
As part of the negotiations, the parties may agree that certain costs are to be deducted from the overage payable. These could include the costs incurred by the buyer in obtaining planning permission, the build costs of the development or the incidental costs of any sales. The specifics of any such deductions will vary between transactions but it is important that these are clearly set out in the original agreement to avoid any disputes when the payment becomes due.
Despite being contingent and possibly also uncertain in amount, overage payments are chargeable consideration for stamp duty land tax purposes. VAT and capital gains are also likely to be relevant. The tax treatment of overage payments is complex and specialist advice should be taken at an early stage.
Exemptions from overage
The parties will often agree to certain transactions being exempt from the obligation to pay overage. These are usually known as "exempt" or "permitted" disposals. Typical examples are disposals:
- to family members of the buyer
- to utility providers for the purposes of development, for example the grant of a lease for an electricity substation
- of affordable housing
The above is intended as a general overview of overage and is not a comprehensive analysis of the relevant law and background. If you have any questions on the above or require advice in this area, please contact our real estate team.
Jonathan Cope