In an abridged version of a past Blundell Lecture, Marie Scott ask why it is that overage causes so many problems
Key questions to ask
- What will trigger the overage?
- How long should the overage last?
- How is the overage to be calculated?
- Are worked examples available?
- How is the overage to be secured?
Overage – the right to share in an increased value that is realised only after the sale or development of a property – is often problematic and the basis of many a dispute. This is largely due to the fact that overage is an attempt to capture a value that is not yet certain, and which may not materialise for many years (if at all), during which time much may change in terms of market conditions, the parties’ relationship, and other unanticipated intervening events.
Disputes also often arise because of poor drafting (whether at the heads-of-terms stage, by the lawyers; by those responsible for worked examples and algebraic formula; or as a result of a disastrous mix), or inadequate security being put in place for the promise to pay the overage.
Questions, questions, questions
The devil really is in the detail when it comes to overage drafting. There is no off- the-shelf precedent for producing overage provisions.
As with all complex legal drafting, allowing time for “cold towel” moments is imperative – time for all parties to test the overage provisions against worked examples and “what if” scenarios.
Drafting overage often starts with a list of questions for the parties to consider.
One of the key issues to consider is what the trigger will be to the overage liability. A common trigger is planning consent for the development or redevelopment of the property. But is the trigger outline or full consent? Does it fall before or after the expiry of the judicial review period? What if consent is granted for development of only part of the land? Who does the planning consent have to be obtained by?
And while a seller might want its overage payment as early as possible, will the developer have the funds available to make a payment before it has developed, sold and realised its profit?
Disposal may be a more appropriate overage trigger, but this brings with it the need to consider what sort of disposals are caught; how inter-group disposals should be treated; and what happens if only part of the overage land is sold.
The calculation of overage is also an important point for detailed consideration. Algebraic formula can be a useful tool for setting out the relevant calculation but, whether words or a formula are used, it is advisable to stress-test them against worked examples.
Questions to ask include: What costs can the buyer deduct from the increase in value before it must pay overage? How are these costs to be checked and verified? How is inflation to be factored in? Should deemed market value be used where a disposal is not made at arm’s length?
The timing for triggering overage liability should also be considered. How long should the overage period last? Too short a period may result in the buyer tactically delaying the trigger date to avoid payment, but the longer the overage period, the greater the potential risks that legislation might change or the courts may interpret existing law in an unforeseen way.
Should the overage be a once-and-for-all obligation or be capable of being triggered more than once in any given period? The latter may help to reduce the risk of a buyer circumventing the overage liability.
What happens if the overage period expires and the trigger has not yet occurred? Should there be a deemed trigger? This may protect the seller against a developer tactically delaying development or disposal, but the developer’s delay may be for good reason, such as lack of funding or market changes.
The importance of security
A contractual obligation to pay overage will not, in itself, bind successors in title. There are various methods for trying to ensure that overage obligations are enforceable in the event of buyer default or against a buyer’s successors in title.
There may be good commercial reasons as to why a seller might agree not to throw the kitchen sink at the issue of securing overage – but simply assuming one’s client will be happy with just a contractual obligation on the buyer to pay overage may end up in a negligence claim, as the solicitors in Akasuc Enterprise Ltd and others v Farmar & Shirreff (a firm) [2003] EWHC 1275 (Ch); [2003] PLSCS 127 found out when they did not even attempt to impose any security.
Some of the means of securing overage obligations include:
• Restriction on title: This can be used to back up a contractual obligation to pay overage, to ensure that the buyer cannot dispose of the property without first procuring a deed of covenant from its successor to the original seller, to comply with the overage obligations.
A buyer will be concerned to ensure that certain “dispositions” are not caught by the restriction, for example, short leases and transfers of common parts to management companies. A buyer will also want to ensure that the time it takes for a certificate to be given in satisfaction of the restriction does not delay any future disposals.
• Legal charge: A seller could take a charge over the property. Once the overage payment has been triggered and the legal redemption date occurs, if the buyer does not redeem the charge by paying the relevant overage, the seller can sell the
land and recover the overage due from the sale proceeds.
However, there must be no “clog on the equity of redemption” – it is fundamental to a mortgage that it is capable of redemption. The parties cannot agree a potentially irredeemable charge, and so a charge will only be appropriate if there is a fixed period within which the overage will be triggered.
A first-ranking charge may prejudice the buyer’s ability to raise finance, which is self-defeating for the seller if development financing is required before the overage value can be realised. The seller may agree to postpone its charge to a subsequent charge taken by a funder, but this is likely to incur additional time and expense in agreeing further financing documentation.
Note also that a seller with a charge will not be able to exercise its statutory power of sale until the mortgage money has become due. So, if the liability to pay overage has not arisen, the seller will not be able to exercise that power of sale, even if the buyer has fallen into financial difficulty.
• Restrictive covenant: While overage is often drafted as a positive obligation to make a payment if a certain trigger occurs, it can also be couched in negative terms, such that the buyer cannot do certain things with the land unless a payment is made. One method of securing such a negative obligation is by way of a
restrictive covenant.
The seller imposes a restriction on the property prohibiting development or a certain use, but covenants to release or modify the restriction upon payment of the overage. However, there are a number of issues with using a restrictive covenant in this way. To be enforceable against a successor in title to the covenantor, the covenant must be made for the benefit of land retained by the covenantee. Therefore the seller must have nearby land that can benefit from the restriction.
Further, while there is a presumption that a restrictive covenant is capable of benefiting the land which it is expressed to benefit, if the covenant does not genuinely preserve the amenity, nature or quality of that land, the covenant will not be enforceable against successors in title to the buyer. Given that the principal aim of the mechanism is to secure an overage payment rather than preserve the amenity of the “benefiting” land, there is a substantial risk that the courts will not enforce the restrictive covenant.
A buyer will have the right to apply for discharge or modification of a restrictive covenant under the Law of Property Act 1925 and such discharge or modification may be granted if it is obsolete, impedes a reasonable use of the land, or if the discharge or modification would cause no injury.
Compensation may be awarded to the seller if the buyer’s application is successful, but the compensation will only relate to the seller’s loss and not the buyer’s gain. It may therefore ignore any overage arrangements and be calculated by reference to the diminution in the value of the seller’s retained land, not the enhanced value of the buyer’s overage land without the restriction.
• Long lease: The grant of a long lease, rather than the sale of a freehold, can be used to secure overage by means of either a negative obligation or a positive obligation.
Under negative obligations, the lease could contain restrictive user and alteration clauses, but the buyer would be entitled to be released from those restrictions on payment of specified overage. This avoids the need for the seller to retain nearby benefiting land and it binds the buyer’s successors.
A breach of the relevant covenants or failure to pay the overage could allow the seller to exercise its right of forfeiture (or at least threaten to do so), subject to the buyer’s rights of relief. However, the seller should beware of the buyer’s rights under the Landlord and Tenant Act 1927 to
carry out certain improvements to the property, potentially circumventing the seller’s ability to enforce the overage provisions if they are linked to restrictions on carrying out alterations.
A positive lease obligation could be a rent increase to take account of any change in use or future development. There would be no need for restrictive alterations or user covenants, rather an obligation to pay the increased rent if certain works are carried out or a change of use implemented. Unlike in a freehold situation, the positive obligation to pay the overage will run with the land. Again, the seller could have the benefit of forfeiture rights, subject to the buyer’s rights of relief.
• Ransom strip: This is a less common method of securing overage. The seller retains a strip of land adjacent to or through the land being sold (or airspace above) which prevents or limits development of, or access to, the overage land. The buyer is entitled to acquire the ransom strip on payment of the overage.
However, a seller should take care to consider whether the buyer could circumvent the necessity to pay overage, for example, by acquiring an alternative access to the site or, over a sufficiently long period of time, acquiring title to the ransom strip by adverse possession.
We started with the notion that overage is often problematic. It is probably safer to assume that it will always be problematic unless sufficient time and attention is paid to the process of drafting the overage provisions.
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Marie Scott is a partner in the real estate team at Nabarro LLP. This article is an abridged version of part of a Blundell Lecture delievered by Marie Scott and Joanne Wicks QC, barrister at Wilberforce Chambers
