Alex Barnes and Emma McPeake compare the development deal choices available to charities which have land they wish to develop
When charities find themselves with surplus land, perhaps left by a supporter in a will or as a result of a premises move, selling or developing that land can be a substantial fundraising opportunity.
As most charities do not typically sell and develop land with any regularity the experience of an expert development partner will nearly always be required. Once a partner has been identified a careful balancing act will be needed to find the middle ground between maximising the charity’s revenue and the developer’s commercial undertaking.
Thought needs to be given to the various ways of structuring the deal and the method of sale that best meets the parties’ requirements will depend on the facts of each case.
Selling to a developer
Option agreement
A call option agreement gives the developer the ability to require the charity to sell the land to the developer at any time within a specified period or on the occurrence of specified events, usually the obtaining of planning permission. The developer is not, however, contractually obliged to purchase the land even if, in this example, an acceptable planning permission had been obtained. For this reason a call option is often favoured by developers, particularly if the viability of the development is not guaranteed, but this option provides little certainty for the charity.
There are advantages to the charity granting an option in that it is able to determine the purchase price for the land once planning permission has been granted. The charity avoids incurring the costs associated with obtaining planning and can also demand an option fee in return for granting the option. The option fee goes some way to mitigating the uncertainty of this kind of agreement and to compensate the charity for being unable to deal with the land for the duration of the option.
Pre-emption agreement
A right of pre-emption gives the developer a right of first refusal to buy the land if the charity landowner decides to dispose of it during an agreed period. It is different from the call option agreement in that the developer cannot force the charity to sell the property. The charity is merely agreeing that if it decides to dispose of the land during the pre-emption period it is obliged to offer the land to the developer first. Therefore, if the charity decides not to sell the land, the pre-emption right never becomes exercisable by the developer.
This type of agreement gives the developer some advantage in the market in relation to the land and the charity the ability to change its mind, although it locks both parties in with no guaranteed sale for either. The charity also runs the risk that the value of the land may decrease during the pre-emption period.
Conditional contract
In practice, a conditional contract is a real alternative to an option agreement. The contract is subject to the satisfaction of certain conditions precedent – usually the obtaining of satisfactory planning permission, vacant possession or statutory consents. Typically the developer is obliged to satisfy the conditions at its own cost and completion of the sale and receipt of the purchase monies is triggered by the agreement becoming unconditional. The contract must define the conditions precedent in detail so that it is obvious when they have been met and disputes can be avoided.
The charity will typically require that the purchase price for the property is determined on the grant of planning as being the higher of a pre-agreed base price or the value of the property with the benefit of planning permission. This allows the charity to benefit from the increased value of the land while the cost of obtaining planning permission is met by the developer and the charity is protected against a falling market.
Although a conditional contract should give the charity more certainty than an option or pre-emption agreement, it is difficult to draft for what will constitute an acceptable planning permission. A wide definition of unsatisfactory conditions to the planning permission could result in the developer being able to pull out of the transaction on a technicality with no significant penalty and the charity is therefore left without a sale. As such the contract can in practice be little more than an option.
Overage agreement
If the main objective for the charity is to have a guaranteed sale, even at a lower price, the trustees should consider including overage provisions in the sale documents.
Overage provisions entitle the charity to share in any increase in value of the land after it has been sold over and above the price paid by the developer. Overage is essentially a form of deferred consideration and is common where there is a reasonable prospect that the land sold will be developed or that a valuable planning permission will be obtained in the short to medium term.
Overage agreements are relatively common as charities disposing of land look to maximise the value achieved to fund their charitable activities. They are an attractive option for a charity as they guarantee the charity an outright sale at an agreed price with the right to benefit from a further uplift. However, they are especially complex and care must be taken when drafting otherwise the charity may not receive the benefit of any uplift.
Furthermore, any overage received by a charity will be subject to taxation. Perhaps surprisingly, charities do not have a blanket exemption from tax on sums made from the disposal of land and where there is overage (or “slice of the action” as HMRC refers to it) unexpected consequences may arise.
Overage agreements fall within the transactions in land anti-avoidance rules. These rules do not require there to be a tax avoidance motive and can therefore catch entirely legitimate commercial transactions. Charities entering into overage agreements will fall foul of these rules and sums received by way of overage will be treated as taxable income.
It may be possible for a charity to avoid this issue using trading subsidiaries. Alternatively, a greater overall fixed price could be charged for the relevant land with any gain on the fixed price being non-taxable. Developers are, however, unlikely to agree to this as they will want to manage their costs and pay as little as possible for the land until they are in a position to generate a return.
Joint venture
None of the above options give the charity any control over the development of the land, nor do they guarantee a certain value that can be achieved. Therefore, as an alternative to an outright sale of the land, the charity could decide to enter into a joint venture agreement with a developer. These are agreements in which the parties agree to act together to develop the land and maximise profits. There is no set formula for a joint venture agreement and the timing and basis on which the parties participate in sale proceeds or uplifted price is a matter for negotiation.
The charity can take advantage of the developer’s experience and skill in obtaining planning permission but is not required to sell the land to the developer. However, as the charity will be in a position to receive a bigger proportion of the profits and will have a greater influence over the outcome, the developer may insist on the charity agreeing to split the initial costs, which will require significant outlay from the start by the charity.
Going it alone
In some circumstances the charity may decide to develop the land itself. While this is rare, provided the trustees consider that they have the requisite expertise to undertake such a project and that it would not be a breach of their trustee duties, there is no reason why this should not be a viable option. Alternatively they could appoint a firm of agents or project managers with experience in this area.
It may be possible to ensure that a lot of the construction costs are zero rated for VAT purposes and any VAT incurred may be recoverable. Advice should be sought at the earliest opportunity in order to understand the costs and other aspects of the project. Depending on the nature and scale of the project, charities should proceed with this type of transaction with caution.
Why this matters
Charity trustees have wide-ranging statutory duties pursuant to charity law (and company law if the charity has been incorporated as a company). While the dominant duty of all charity trustees is to advance the purposes of their charity, when it comes to the development of charity land the following obligations are particularly relevant:
- safeguarding and protecting the charity’s resources and assets;
- exercising proper stewardship over the assets of the charity;
- ensuring that the charity operates in a manner consistent with the charity’s constitution and the law; and
- acting at all times in the best interests of the charity and in good faith.
In addition, there are special rules that apply when charities dispose of land and the trustees must be satisfied that the disposal is on the best terms possible for the charity.
The general position under the Charities Act 2011 (the “2011 Act”) is that no land can be disposed of by a charity without the consent of the court or the Charity Commission. However, in the majority of cases the trustees will be able to make disposals without having to seek such consent provided that the appropriate procedures under the 2011 Act have been followed.
The legislation seeks to ensure that the trustees are disposing of the land on terms that are the best that can be reasonably obtained in the market by requiring the trustees to obtain and consider a written report on the proposed disposition from a qualified surveyor acting exclusively for the charity. The report must cover the prescribed matters referred to in the 2011 Act including the market value of the property and also advice on how the land should be advertised.
The trustees must also follow further procedural steps where land is held on trusts that require the land to be used for the purposes of the charity. The risk in not doing so is that the transaction could be rendered void and the trustees could be jointly and severally personally liable for any losses arising to their charity as a result of a breach of any of their duties.
Further reading
Charities Act 2011, sections 117 to 129
Schedule to the Charities (Qualified Surveyors’ Reports) Regulations 1992 (SI 1992/2980)
Alex Barnes is a tax partner and Emma McPeake is an associate in the real estate team at Irwin Mitchell LLP
