What is overage and how does it work?
26 July 2021
Overage should be an important consideration for parties to strategic land transactions but what is it and how does it work?
Overage is a contractual mechanism which allows a seller of land to potentially benefit from any subsequent increase in the land’s value after having sold it. Overage agreements, also commonly referred to as claw-back, uplift or anti-embarrassment agreements, should therefore be an important consideration for parties to the sale of land, particularly where the land has development potential.
How can overage benefit you?
From a seller’s perspective, overage can help to maximise their potential financial return from the sale of land by receiving both initial consideration for the land on completion, as well as a share of any future increase in value following the sale. For example, overage is commonly sought by a seller where there is a reasonable expectation that the land being sold will subsequently increase in value by virtue of obtaining planning permission and/or being developed.
Overage can also offer sellers peace of mind by helping them claw-back any future uplift in value where the land may have been inadvertently under-valued at the point of sale (hence the name “anti-embarrassment”!). This might be a particularly useful mechanism where full consideration of the land’s future development potential is not feasible prior to its sale, where planning changes might reasonably permit additional lucrative uses of the land in the future or where a seller wants to dispose of the land quickly at a discounted rate but without missing out on the true value of land in the longer term.
However, the commercial benefits of overage are not exclusive to sellers. Buyers can also seek to utilise overage as a strategic means to avoid over-paying for a potential development site. As overage payments are usually contingent on any future increase in the value of the land, buyers can take advantage of overage by paying a lower initial sum for the land on completion rather than an inflated value based on the land’s anticipated development potential, which may never be fully realised.
What are the essential elements of an overage agreement?
While overage can operate in a multitude of different ways, there are four essential elements to any overage agreement:
- triggering events
- how overage is to be calculated
- how the buyer’s obligation to pay the seller any overage is secured.
It is important to note that overage agreements can only take effect for a finite period of time following a sale of land. While agreements can range from anywhere between 5 to 20 years, or even up to or exceeding 50 years, the duration of any given agreement will generally be a matter of fact and degree, depending on the nature of the transaction itself and the parties’ respective negotiating positions.
As a general rule, a seller will usually prefer a longer overage period whereas the buyer will often seek to minimise the length of any agreement.
In practice, an appropriate overage period might correspond to the timeframe within which the parties believe it would be reasonable for a specified event to occur, such as how long it might reasonably take for a buyer to obtain planning permission or to begin development. The buyer’s intended plans for the land may also affect the appropriate length of any overage period. For instance, if a buyer intends to develop a site immediately a shorter duration would likely suffice whereas, if the buyer intended to purchase the land as a long-term investment with no immediate development plans, a longer overage period might be more desirable for the seller.
Sellers can also seek to utilise the duration of an overage agreement as a means of retaining a degree of control over the land following its sale. If a seller is reluctant for the land to be developed in the future, they may seek to impose a longer overage period in an attempt to deter the buyer (or subsequent buyers) from developing the land.
Buyers should be acutely aware of the duration of any overage provisions affecting the land because it may impact the commercial viability of the transaction. If a buyer intends to develop the land within the overage period this is likely to significantly increase their development costs. Similarly, where a buyer is deterred from commencing development within the overage period, they should consider whether the extended timeframe for commencing the development remains satisfactory.
Events triggering payment
A buyer’s obligation to pay overage will usually be triggered on the occurrence of a specified, pre-agreed triggering event. A triggering event will typically be an event which has the potential to increase the value of the land. Common examples of triggering events include:
- The grant of planning permission for the development of the land
- The implementation of such planning permission (e.g. the commencement of any subsequent development)
- The subsequent sale of the land at a higher value
- The subsequent sale of the developed land or individual units (e.g. the sale of houses on a residential development).
A seller will usually want overage to trigger as soon as possible and within the overage period in order to realise any overage payment. In contrast, a buyer is likely to prefer a triggering event which occurs later in the development process. This is not only because the longer it takes for a triggering event to occur the more likely it is that it might occur outside of the overage period, but because the buyer is unlikely to want to trigger the obligation to pay overage until it can be sure that the intended development will proceed and that it will actually be able to realise any increased value of the land.
For example, a buyer is likely to resist agreeing to overage triggering on the grant of planning permission because the permission might not be satisfactory for their intended development. Also, obtaining planning permission will not, in and of itself, necessarily commit the buyer to proceed with the development. A buyer is much more likely to insist that overage is only triggered when either: (i) the development commences; or (ii) the developed land is subsequently sold.
Parties should ensure that they understand precisely what circumstances will trigger overage and should seek professional legal advice as early as possible in the transaction to ensure that the agreement is drafted sufficiently tightly. In particular, sellers should be wary of any loopholes which the buyer might try to exploit to avoid triggering overage.
In the recent case of Sparks v Biden  EWHC 1994 (Ch), overage was to be triggered on the sale of the last of several newly-developed houses. However, the developer sought to avoid triggering overage by instead occupying a property himself and leasing the remainder on a short-term basis. On a strict interpretation, this appeared to frustrate the overage provisions under the agreement. While the court came to the seller’s rescue, holding that the developer had an implied obligation to take positive action to sell the houses, this case should serve as a warning to sellers as to the issues which might arise where agreements are not drafted sufficiently tightly. Sellers should therefore also consider expressly committing the buyer to using reasonable endeavours to apply for planning permission or to complete, market and sell any future development.
Method of calculation
Overage can be calculated in a number of different ways and will ultimately be a matter for negotiation between the parties. We would strongly recommend that both parties seek advice from an experienced surveyor on the various different methods and formulae that can be used.
Some common examples include: (i) a pre-agreed percentage of any increase in the value of the land (e.g. following the grant of planning permission); (ii) the payment of a fixed sum for each unit developed on the land (usually in excess of a fixed ‘base’ number of units); and (iii) a pre-agreed percentage of the buyer’s profits from their subsequent sale of the land (minus any development costs incurred).
When deciding the most appropriate method to be used, parties should ensure that the agreement sets out how any increase in the value of the land will be determined. For example, by setting out a fixed ‘base value’ for the land against which any subsequent increase in value can be assessed and the mechanisms by which any increase in value can be determined, preferably by an independent surveyor. Likewise, where overage is to be calculated on the basis of actual sales proceeds, the seller should seek to ensure that the best value has been achieved by the buyer. We would recommend including at least one worked example to illustrate how any calculation will work in practice.
Protection and security
Sellers should also consider how they can protect or secure the buyer’s obligation to pay any overage due to them. While the agreement itself will create a personal contractual obligation on the buyer to pay the seller any overage which falls due, in and of itself, this will generally be inadequate for the seller. This is because the buyer might be of insufficient financial strength or may even cease to exist at the point any overage is to be paid in the future. Therefore, a seller will almost always seek to secure their right to any future overage payments against the land itself.
The terms of any such protection or security will be a matter for negotiation between the parties but might include:
- Registering a restriction on the buyer’s title to the land, prohibiting the buyer from further selling the land unless their future purchaser also agrees to be bound by the overage; and/or
- Registering a legal charge over the land such that, when the buyer wishes to subsequently dispose of the land, the buyer would be required to either redeem the charge by paying to the seller any overage due or ensure that the subsequent purchaser of the land also enters into a charge to continue to protect the overage.
Your solicitor will be able to make the necessary Land Registry and Companies House applications on your behalf to ensure that any overage obligations are correctly secured against the land in question.
The content of this article is for general information purposes only. For further assistance or advice please contact a member of Birketts’ Commercial Property Team.
The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article please contact the author in the first instance. Law covered as at July 2021.