206: Avoiding the pitfalls in overage agreements
In property development, overage agreements are never simple and often full of hidden traps.
Overage is often reserved by a seller of property to receive additional money if the buyer of that land makes an extra profit in the future. Overage agreements are most commonly used when selling property with development potential, for example, they can be used to capture value if the buyer ‘flips’ the property for more than they purchased it or if they obtain planning permission. They can also avoid the embarrassment of under-valuing a property or even overlooking a planning opportunity that a developer may have spotted.
A recent case (Morris Homes Limited v Cheshire West and Chester Council) serves as a reminder of how important it is for the agreement to be precise.
In this case, land was sold by a council to a developer to build a block of flats. The council reserved overage based on the actual revenue received from ‘disposal of the units’. As well as selling the flats, the developer sold the freehold of the block (known as a ground rent sale) subject to the flat leases which created an additional capital receipt. The key question was whether the ground rent sale should count towards the sales revenue in addition to the flat sales. The Court of Appeal held that this was the case so the developer had to pay overage on the ground rent sale which they had not expected.
This is an example of how overage based on sales revenue raises a number of issues, which often are not immediately apparent from the initial heads of terms and the care that needs to be taken when drafting overage.
When dealing with an overage it is important to consider and be clear about the overage period, the ‘triggers’ for payment, how the overage payment is to be calculated, and how the overage payment is to be secured in the future.
It is vitally important that expert advice is sought to ensure that overage agreements are drafted for clarity with worked examples that demonstrate that the agreement fulfils the intentions of the parties to avoid future complications.