Sellers of land with development potential can benefit from its increased value, but deals must be correctly structured. Duncan Murphy explains
Everyone wants the best deal. One way to achieve this is by apportioning some – or almost all – of the price for land into a future right to overage. Put simply, “overage” is the right to receive further payments if, and when, certain events occur.
In a typical scenario, a buyer will offer to pay £x for a freehold interest in land. The seller hopes that the buyer will secure planning permission to put the property to a more profitable use. It does not want to lose this “hope” value. One way of addressing this concern is by reserving the right to receive a proportion of the increase in the value of the land when planning permission is granted.
Structuring the deal
A fixed sum or percentage of open market value?
For peace of mind, a seller may want to specify a fixed sum, but it will have to pay capital gains tax on that sum immediately after completion of the sale of the land. Structuring the deal in this way will also increase the stamp duty bill. The seller should also be wary of the risk of inflation (unless the overage is index-linked to minimise the effects of any inflationary pressures).
The buyer may prefer to pay a percentage of open market value, to encourage greater flexibility in terms of development. If the seller is concerned about this, why not place the buyer under an obligation to maximise the value of the property and to account for the overage at the earliest opportunity? If the seller requires progress updates, include this in the contract. As an additional safeguard, why not agree upon a minimum that the buyer will have to pay by way of overage?
For how long?
The right can be drafted in such a way that it will endure for up to 80 years (or in perpetuity, if protected by a restrictive covenant). If the land has genuine hope value and there are adequate release mechanisms, my own view is that the seller should have a reasonable period within which future moneys could become payable. However, it must surely be possible to realise any genuine hope value well within 80 years.
Triggers?
The obligation to pay overage may be triggered by the grant of planning permission or the service of written notice that the buyer intends to commence development.
Buyers may prefer to avoid triggers that depend solely upon the grant of planning permission. Permission may be outline only. Even a full permission may be unacceptable if it is subject to conditions (for example, a large social housing provision) that make the potential development uneconomic.
The parties may agree that the overage provisions will apply if the local planning authority grants a permission that is capable of implementation; but remember that the seller (or others acting on the seller’s behalf) could also apply for planning permission. This could trigger the obligation to pay overage if the contract does not contain any provisions to prevent this.
One or more bites of the cherry?
Sellers need to think ahead. Could the buyer obtain a low-value permission, pay overage on it, and then reapply for a more lucrative permission? The overage provisions should be wide enough to cover this.
Securing the payments
A contractual obligation?
The Contracts (Rights of Third Parties) Act 1999 transfers benefits, not burdens. The obligation to pay overage will not bind future owners, and will not survive insolvency. However, the mechanism could be suitable if the buyer already has planning permission for development, and will only be liable to pay overage if sales exceed a certain level, although the seller should consider the need for additional forms of security to guard against any future insolvency.
Chain of positive covenants?
This device is just as reliant upon the financial strength of the buyer and future owners of the land. It will only operate successfully if the buyer and seller apply (in the transfer) to the Land Registry to register a restriction against any further dealing with the land in the title. The Land Registry will then refuse to register anyone else with title to the property until the applicant has entered into a legally-binding obligation, or deed of covenant, to pay the overage. The applicant should be required to accept a similar restriction upon any further dealings, otherwise the mechanism will soon collapse.
Restrictive covenants?
Restrictive covenants – not to build without paying the overage – do potentially bind successors. The seller will need to retain land capable of benefiting from the covenant, but will subsequently be free to sell further parts (but not all) of that land, with or without the benefit of that covenant. The covenant will have a negative effect upon the value of the land, but the buyer will be free to use the property as security for future lending.
A right of re-entry?
Sellers rarely rely upon this. However, sellers could use this device to counter the effect of section 84 of the Law of Property Act 1925 – which provides a mechanism for landowners to apply to the Lands Tribunal to modify restrictive covenants – by reserving the right to take the property back if any such application were made. However, most buyers would regard this as a draconian solution (which could now be liable to challenge under the Human Rights Act 1998) and most lenders would reject any security that could be lost in this way.
Legal charge?
This is a very effective remedy, because the legal charge will normally include a power of sale if the buyer defaults. The buyer should try to limit the power of sale to non-payment of the overage (ie it should not extend to breaches of any obligation to apply for, or obtain, planning permission). However, this may render the property unsuitable for use as a security – unless the seller concedes priority to the buyer’s lender.
Ransom strip?
Speak to a surveyor about which land to ransom. The buyer will require an option to acquire the ransom strip. The seller will seek to ensure that the option is only exercisable when the overage has been paid.
Release mechanisms
A deed of release or certificate from a solicitor confirming payment?
These mechanisms are not foolproof unless they are immediate. Significant delays may occur if the buyer pays the overage, but then has to start legal action to secure a formal release because the seller has not complied with its obligation to provide one. The death of the original landowner could also cause delay, as could the discovery that the solicitor named in the documentation no longer practises. The seller should be required to produce this document, in an agreed form, upon payment of the overage.
Automatic or deemed release upon payment of the overage?
A mechanism like this will circumvent these problems, but the seller may be reluctant to relinquish control in this way. Remember, it will operate successfully only if the buyer’s solicitor can instruct the Land Registry to remove protective entries on the registers of title as and when the overage is paid.
Situations in which a release may be required include:
” Sales of completed dwellings or units. Lenders may not accept dwellings or units subject to overage obligations.
” Where the new owner has entered into a legally-binding obligation – to eliminate any contingent liability, which the buyer would otherwise retain.
” Sites for electricity substations, gas governors or pumping stations, and land that is to be dedicated or transferred to a local authority for roads, footpaths, verges, open space etc – statutory authorities and/or utility companies may refuse to accept land that is subject to overage.
Common pitfalls
Section 78 LPA 1925
You ignore this at your peril. The buyer and seller can, and should, exclude this, at the outset, to ensure that the seller has an exclusive right to release any restrictive covenants securing payment of the overage.
Equitable lien
A seller has an equitable lien over land until the entire purchase price has been paid (see Holding back the lien’s share, Estates Gazette 6 May 2000).
The obligation to pay overage could give rise to an equitable lien. The seller would then have the power to apply to the court for an order for the sale of the land, in order to pay the overage. This could, in turn, render the property unsuitable for use as a security. However, buyers are able to sidestep this problem if they wish to do so – an unpaid seller’s lien can be modified or excluded by express agreement between the the parties.
Duncan Murphy is a solicitor in the property group at Wragge & Co|
Key points |
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” Sellers use overage to maximise the price paid for land with development potential |
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” It is vital to structure such deals correctly |
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” Poorly drafted release mechanisms give sellers the whip hand |
