What is an overage agreement?
What is an overage agreement?
An overage agreement is an agreement whereby a purchaser of land agrees to pay the seller an additional sum of money (on top of the purchase price) following the occurrence of a future specified event that enhances the value of the land. This allows the seller to share in the enhanced value following the sale. Overages are sometimes referred to as “clawback”, “uplift” or “anti-embarrassment” mechanisms in property transactions.
As a result, overage agreements are popular with sellers of land with development potential and they also enable buyers to purchase land for a lower initial purchase price but with the condition that the buyer pays further sums to the seller if the land gains value in the future.
If you are selling or buying land, it is important to understand the way an overage agreement can be used, whether this might be appropriate for your situation and, if so, what the terms of that agreement should be.
In this article, we cover some of the key things you need to know about overage agreements so that you can have a general background on the subject. However, this should not be taken as specific legal advice, so please speak to our specialist overage agreement solicitors if you require support.
Key points covered in this article:
- What are the different types of overage?
- What key provisions should be included in overage agreements?
- Who benefits from an overage?
- Why may a seller use an overage agreement?
- How is the payment calculated for an overage agreement?
- What tax considerations are there?
- How do you protect the obligation to pay the overage?
What are the different types of overage?
The three main types of overage are as follows:
1. Planning overage
Planning overage is an uplift payment payable once planning permission has been obtained which increases the value of the land.
The trigger events for payment include the grant of planning permission, the grant of planning permission immune from challenge, the implementation of planning permission and/or the disposal of the land with the benefit of planning permission. It is best for the trigger event to be the implementation of the planning permission rather than the grant. This avoids a situation where a buyer pays the planning overage following the grant of the planning permission, but then the permission is quashed or revoked leaving the buyer out-of-pocket.
The overage agreement should always include a formula and worked examples so all parties know how to calculate the overage payable with reference to example scenarios and figures.
The parties may agree certain deductions from the overage payment such as the buyer’s costs of obtaining the planning permission, the original price paid for the land, any previous overage payments already paid and other costs/expenses the buyer will incur as a result of obtaining planning permission and/or paying the overage.
The parties also need to agree whether the overage should be a one-off payment whereby the overage provisions terminate in relation to the land once payment has been made or whether the overage provisions should continue to apply (a “rolling overage”). This means that if a buyer or their successors in title later obtain a more valuable planning permission than the one originally granted, then a further planning overage payment would be payable to the seller.
2. Sales revenue overage
Sales revenue overage is an overage that is mainly payable where the buyer develops land for residential purposes, sells off the individual units and expects the sales to generate a certain revenue above a base figure. The seller can share this additional revenue via the sales revenue overage.
The trigger event for payment is commonly exceeding the agreed base revenue figure. The overage agreement should always include provisions whereby the buyer must provide sales updates to the seller and an obligation on the buyer to inform the seller once the sales revenue exceeds the base revenue figure so the buyer and seller can calculate the overage payable.
It is usual to have certain deductions from the calculation, for example, sales revenue from affordable housing units, build cost inflation, plot purchasers’ incentives/extras, the buyer’s sales costs, part exchange properties and other reasonable costs incurred by the buyer. The result being that sales revenue overage is payable on the net sales figure after all costs/incentives.
The size of the development determines when payment should be made i.e. in stages (quarterly or annually) or once the last unit on the development is sold.
The overage agreement should always include a formula and worked examples so all parties know how to calculate the overage payable with reference to example scenarios and figures. With sales revenue overages, it is important to deal with a situation where the overage is payable even if the buyer does not sell the last unit on the development. This is usually done by including a longstop date and if the last unit is not sold by this date, then that unit is given a “deemed disposal value” and sales revenue overage is calculated and paid based on such value.
3. Sale at a profit
This overage is payable when a buyer sells undeveloped land at a profit shortly after purchasing it without the benefit of planning permission (i.e. the buyer “flips” the land at a profit). This would leave the seller in an embarrassing position, and to avoid such embarrassment, an overage may be agreed whereby the original buyer agrees to pay all or part of the profit to the original seller.
What key provisions should be included in overage agreements?
Now we have identified the most common types of overages and their trigger events, it is important to include a list of “permitted disposals.” By including a list of “permitted disposals” the buyer can dispose of the individual units and other parts of the land without triggering payment of any overages (so the buyer can generate revenue and discharge its obligations under any planning agreements) and such “permitted disposals” will then be free from the overage provisions moving forward.
The following should always be included in any list of “permitted disposals”:
(a) sales of individual units constructed on the land (i.e. plot sales);
(b) sales of affordable housing units constructed on the land;
(c) transfers of land to any statutory authority/body concerned with planning, drainage, highway, other infrastructure or environmental matters or utility companies concerned with the installation of services;
(d) transfers of any land to a local authority;
(e) transfers of any land to a management company;
(f) transfers of any land to a highway authority for the purposes of adopting the roads/footpaths/cycleways/open space to be constructed on the development; and
(g) any mortgages or charges of the land.
Overage agreements should always include a specific date on which the overage obligations will expire (i.e. the “Overage Period”) and a good-faith and double-counting clause. Such clauses prevent double-counting where there is more than one overage payable and requires buyers and sellers to act in good faith towards each other.
Another consideration is whether the benefit of the overage can be assigned by the seller to a third party. If so, the overage agreement should include a clause whereby the seller must notify the buyer in writing of the seller’s intention to assign to a third party and the seller should be obliged to provide that third party’s details to the buyer and enter into a deed of covenant directly with the buyer whereby that third party agrees to observe and perform the seller’s obligations in the overage agreement.
For specific overage agreement tips relevant to your situation, please speak to a member of our team.
Who benefits from an overage?
Both the buyer and seller can benefit from an overage agreement. The benefits of overage clauses will depend on which side of the transaction you are on.
For the seller, the key advantage is that they will benefit if the buyer later develops the land in a way that significantly increases its value. For example, if the land being sold is farmland, but the buyer later obtains permission to build housing there, the land’s value would then be substantially higher than its value as farmland. If there is no overage agreement in place, the seller might then feel they have lost out.
For the buyer, an overage agreement allows them to purchase land at a lower price e.g. at farmland prices rather than at the price they would pay for land with development rights. The key advantage here is that, if the buyer fails to get permission for a development, they will not have paid a higher rate than the land’s value as farmland.
For both seller and buyer, an overage clause therefore acts as a form of risk management. The seller is protected against the risk of the land’s value increasing after the sale and the buyer is protected against the risk of not being able to use the land in a way that would increase its value.
Why may a seller use an overage agreement?
As covered above, a seller will generally use an overage agreement where they are selling land that they feel has the potential to be developed by the buyer in a way that would substantially increase its value.
How is the payment calculated for an overage agreement?
Typically, the payment to the seller set out in an overage agreement would be based on a percentage of any increase in value of the land that would be achieved if planning were granted or the property was sold on by the buyer within a particular time frame.
However, the terms of an overage agreement can, essentially, be whatever a buyer and seller agree on, so a different mechanism could be used for calculating any overage payment if this was considered appropriate.
What tax considerations are there?
For sellers, if capital gains tax is payable on the initial sale, then capital gains tax will likely be payable on any overage payments. Sellers should obtain specialist tax advice to deal with any capital gains tax payable and whether such tax can be deferred.
For buyers, stamp duty land tax is payable on any overage payments and if VAT was payable on the initial purchase price, then VAT will be payable on any overage payments. Buyers may apply to HMRC to defer payment of stamp duty land tax on any overage payments until the overage has been calculated and paid.
The parties may agree that the additional stamp duty land tax payable by the buyer on any overage payments may be deducted from any overage payments. In such circumstances the formula and worked examples within the overage agreement should reflect this. Again, buyers must obtain specialist tax advice on such matters.
How do you protect the obligation to pay the overage?
- The seller can take a legal charge (mortgage) over the land. Where the buyer needs to mortgage the land to a bank to buy the land or develop it and the buyer’s lender agrees to the seller taking a legal charge to protect the overage then the seller will receive a second legal charge. However, some lenders will not consent to a second legal charge so this may not be a practical option.
- The seller can retain ransom strips around the boundaries of the land, giving the buyer an option to purchase the ransom strips on payment of the overage. Therefore, until the overage is paid to the seller the seller retains some land surrounding the development and can control the land being developed (e.g. by controlling access to the development).
- A restriction can be registered against the buyer’s title to the land at HMLR prohibiting the buyer from selling it on without the seller’s consent, which would only be granted upon payment of the overage or the new buyer entering into a deed of covenant to comply with the terms of the overage agreement. This is the most common and preferred method of securing the overage obligations. If you use this method then you should ensure that there are provisions in the overage agreement to deal with the removal of such restrictions promptly following payment of all overages/the expiry of the overage period.
On a final note, as overage payments are a complicated subject it is always best to include a disputes provision in the documentation in the event the parties cannot agree on the amount of overage due. This helps to provide a secure overage agreement that minimises the risk of costly, time-consuming problems later on.
Contact our residential development and housebuilding solicitors today
Our New Homes team acts for both local and national housebuilders in the sale of completed developments to both owner occupiers and investors. We can act as overage agreement solicitors for a wide range of transactions, giving the benefit of our many years of experience with these matters.
The New Homes Division is part of a wider residential development team that also advises on the acquisition of residential development sites, infrastructure agreements and Housing Association disposals so as a firm IBB can offer a full and complete service to our housebuilder and residential developer clients.
For more information or to discuss your requirements call us now on 03456 381381, or email us at firstname.lastname@example.org.
An earlier version of this article was first published in the Solicitors Journal.