Overage: Avoiding the pitfalls

What is an overage?

An overage is a contractual obligation entered into by a land purchaser (typically a developer) through which it agrees to make a further payment to the seller once a specified ‘trigger event’ occurs – for example, where the developer increases the value of the land by obtaining planning permission. It arises most frequently in the sale of undeveloped land that is being purchased for development typically where the nature and extent of the development has yet to be determined and the developer wishes to avoid paying the full potential land value upfront.

Why is overage popular?

Overage enables a seller to benefit from an increase in the land value after the land has been sold.

From a developer’s perspective, an overage agreement can enable it to acquire property for a lower initial price but often on the condition that it commits to making a further payment if it is successful in subsequently increasing the value of the land.

Overage is usually calculated as a percentage of either the increase in land value attributable to the planning permission authorising a change of use or development or the net sale proceeds. Alternatively, the additional payment could be based on a fixed figure for each additional unit constructed or an agreed rate based on additional square footage achieved.
The negotiation of the overage percentage and the length of the term over which such payments are to be made are not normally contentious. There are, however, many other overage variables that require careful consideration, some of which are summarised below.

1. Securing the additional payment

Normally this is achieved by way of a charge or by way of a positive covenant and a restriction on the legal title to the land. Other ways to secure the overage include a security bond or guarantee being given, retention of a ransom strip or restrictive covenants being placed over the land being sold. The most effective way to protect the payment should be considered on a case-by-case basis and may involve a combination of different measures.

2. Deductions

Obtaining planning permission, complying with section 106 agreements and satisfying infrastructure requirements can be very expensive. The developer should ensure that these costs are reflected in the final uplift payment calculation even though the seller will want to limit these deductions as far as possible.

3. The payment trigger date

An overage can have any number of payment triggers. A seller will want to receive the uplift payment as soon as planning permission has been granted. To avoid cashflow issues, however, the developer will only want the payment trigger date to arise where either the planning permission has been implemented (since by then a developer would typically have organised its development funding) or where the developer has realised the uplift in value from the disposal of the land benefiting from the new planning permission.

4. Single or multiple overage payments

The overage deed needs to be drafted carefully so that it is clear when it is intended that the overage payment will end. It might be that the overage falls away after a single payment has been made or it may instead be negotiated that overage becomes payable on each and every trigger date that arises during a fixed overage period. Multiple triggers can be onerous and can cause issues for funders and subsequent buyers. In all cases, worked examples should be considered and included within the draft documentation to avert future disputes.

5. Cost of providing consent to a disposal

The developer is normally responsible for the seller’s costs in formally consenting to a disposal but where there are likely to be multiple plot sales each requiring a separate consent then it would be prudent for the developer to limit or otherwise cap its exposure.

6. Exclude ‘Permitted Disposals’

It is not usually intended that disposals such as the grant of legal charges, short leases or easements are intended to form part of the overage. However, the overage agreement needs to be clear on exactly which disposals are permitted to avoid both disputes and the unnecessary payment of costs for giving consents.

Conclusion

Overage provisions need to be carefully drafted to ensure that the terms agreed in principle are accurately documented to avoid unintended consequences. It is essential that the principal overage terms are considered and agreed at the outset in conjunction with professional advice to ensure that the parties’ interests are effectively protected.