Thinking about overage

Overage provisions are a common feature of the development landscape, helping to ensure that a landowner receives a “fair” price for its land.

Introduction

Overage provisions give a landowner the right to receive a future payment following the sale of the property if the developer enhances the value of that property. 

For residential developments, overage may be payable if the developer’s profit from the sale of flats and houses exceeds an agreed threshold. Careful consideration needs to be given to how the developer’s profit is calculated and what should and should not be included in the calculations.

Many disputes involving overage tend to revolve around gaps or ambiguities in the drafting of the overage provisions and so thinking ahead to reduce the scope for those gaps and ambiguities is essential. Recent cases illustrate the lengths to which parties will go to avoid paying overage (as reported in our article, Landowner wins the day on overage). Neither party will thank their legal advisors if, five or six years later, problems arise and the original intentions of the parties are not fully met. Some examples where a little thought can prevent lots of problems are discussed below.

Ground rent investments

Assume a developer has agreed to pay overage based on the sale proceeds from a block of flats exceeding an agreed figure. The developer sells 50 flats for £12.5 million. The landowner receives overage of 50% of the sale proceeds above £11 million. Accordingly, the developer pays overage of £750,000. 

Following the sale of the flats (all of which reserve a ground rent) the developer sells the ground rent investment for a further £150,000. Does the profit from the sale of the ground rent investment form part of the overage calculations? 

If the overage agreement is silent on the question, there is scope for dispute. The developer will argue that the terms of the overage agreement do not cover the payment. The landowner will argue that the sale of the ground rent investment forms part of the development profit and should be included in the calculation. Sales of ground rents should be expressly addressed in the overage agreement.

Part-exchange properties

Should a developer’s acquisition costs on a part-exchange property be deducted from the profits included in an overage calculation? For example, a developer might sell a house for £800,000 and, as part of the consideration it acquires the buyer’s existing property valued at £450,000.

The developer will have paid legal fees, possibly stamp duty land tax and Land Registry fees on the acquisition of the part-exchange property. It would argue that these should be deducted when calculating overage. The landowner’s response would be that the developer’s value attributed to the part-exchange property was already discounted to take into account acquisition costs and so to deduct them is to double-count the same costs. The overage agreement should make it clear whether or not acquisition costs are deductible.

If, two months later, the developer sells the part-exchange property for £550,000, should the developer’s profit from the sale of the part-exchange property, after deducting disposal costs, be treated as part of the developer’s profit from the development? The overage agreement should make this clear as well.

Extras and incentives

A developer may provide extras and incentives to the buyer of a flat or house. Extras are typically provided at no cost to the buyer and may include the provision of curtains and blinds, carpets, floor coverings, floor and wall tiling, white goods, lighting, fitted furniture and other household items. Incentives may include paying the buyer’s legal fees, stamp duty land tax and removal costs.

Unless the overage calculation makes express provision for the deduction of these items from the overall profit, there will be scope for disputes about the developer’s profit on each sale. Developers will want the cost of extras and incentives to be deducted from their profits. Landowners will want to ensure that the developer cannot artificially reduce its profits. 

The overage agreement should allow only the cost of extras to be taken into account in relation to those that are provided above an agreed base specification. Where appropriate, there might be a cap on the amount or types of incentives that can be offered to the buyer.

Unsold units

The period during which overage is payable will usually be time-limited or the overage may not be payable until the last of the residential flats or houses has been sold. In either case, the landowner may lose out if the developer leaves flats or houses unsold until the period for paying overage has expired. 

In Renewal Leeds Ltd v Lowry Properties Ltd [2010] EWHC 2902 (Ch), overage was not payable until the last house on a development was sold. The developer deliberately left the last 4 houses unsold to avoid paying overage. The court implied a term into the overage agreement that the developer should take all reasonable steps to sell the houses and therefore the overage was payable. 

To avoid this, overage agreements should provide for a deemed disposal at open market value at a suitable point in time to allow the final calculations to be made. Typically, a final calculation may be made when 90 to 95% of the flats and houses have been sold.

Conclusion

The profits and deductible amounts to be included in an overage calculation where the overage is based on the proceeds of sale from flats and houses will be a matter of commercial agreement between the landowner and the developer. 

It is important is that the intentions of the parties are considered at the outset of the transaction and that careful thought is given to where the development profits will arise. 

There needs to be clarity throughout the lifetime of the development about those intentions and what profits can and cannot be included in the overage calculations.