Overage Agreements in Commercial Property Transactions.

Lanyon Bowdler can advise on all aspects of overage agreements for buyers, sellers, and developers alike, so no matter what your role is in the arrangement, you can protect your interests.

The basic terms of an overage agreement include:

• Duration (typically from 5 to 25 years though this can be more)
• Conditions (as mentioned above, the circumstances that trigger a payment)
• Size of payment (usually a fixed percentage of the additional marketable value typically 25% – 50%)
• Security (e.g. does the owner/developer retain a legal charge/freehold? Restrictions on dealings)
• Release (under what conditions does an overage payment end the agreement?)

It’s important to consider all the above, particularly the latter points as these can protect buyers against being asked to make repeat payments over an indefinite period, while also protecting the developer/seller against unsecured overage agreements and exit loopholes.

For both parties, it’s beneficial to secure overage payments against the property in some way, to avoid disputes in the event that the future buyer is unable to pay in cash.

Some methods of doing this include:

• A legal charge over the land (although this may cause problems when applying for bank loans secured on the land too).
• Retaining a ‘ransom strip’ that is only released to the buyer once any applicable overage is paid.
• Retaining the freehold. Selling the land as a leasehold property allows overage to be included as a persistent tenant covenant that continues to apply to all future tenants.
• Imposing restrictions against registration of future dealings.

It may seem logical to release the overage obligation upon payment, but this can raise legal risks of its own. For example, a future developer might seek planning permission for close to the agreed threshold of new properties, to minimise the overage charge payable.

Once they are constructed, the developer could theoretically seek further permission to extend the estate, without paying any more overage.

To prevent such loopholes, it is quite common for overage contracts to include a good faith clause, or to set a minimum amount of overage payable before the agreement is terminated or for further enhanced development to trigger additional overage payments.

The investment property market is hard to predict, especially in turbulent economic times, but overage is essentially a way to iron out some of the ups and downs.

It allows you to buy and sell property at any time while factoring in future moves in the market – particularly good for sellers to protect their potential gains ahead of a likely rise in market value.

For buyers, the benefits include the ability to buy a plot of land that is about to rise substantially in price, on the understanding you only pay a portion of that additional value at a time when the funds to do so are available to you.

In this way, although overage agreements might seem to favour the seller financially, they can be mutually beneficial; however, in any such long-term arrangement, expert legal advice is essential to avoid loopholes and disputes arising.

We can include overage in larger contracts of sale, so that the arrangements are incorporated into the overall terms from the outset.

There are some important things to consider about overage agreements that can have a big impact on how much you receive as the developer/seller or how much you must pay as the buyer.

Duration is a factor as it affects the length of time over which the future owner of the property will potentially face overage charges. This in turn can make the property less saleable as the perceived gains for future buyers will be smaller.

At the same time, it’s important to ensure the duration of an overage agreement is enough to cover future development of the land; for example, a five-year overage arrangement might be quite short to allow for a new estate to be built, marketed, and sold at a profit.

Because of this, it is also common for the trigger to be the commencement of construction works, or the resale of the land with planning permission granted, rather than when construction is completed, and the new premises are sold.

Commencement, rather than immediately upon planning permission being granted, means the seller does not have to wait too long for their overage payment, but also allows the subsequent buyer to secure full funding for their development before incurring an overage charge. It also protects the developer from triggering a payment when the planning permission isn’t implemented and thus no benefit has at that stage been derived.