Seller beware - overage clauses
This article was included in the spring 2011 issue of Informer - the real estate newsletter.
The recent case of Renewal Leeds Limited v Lowry Properties Limited is a reminder of how important it is to draft overage provisions clearly and comprehensively. In this case, there was an agreement, conditional on planning, for the sale of land to a developer. In addition to the basic sale price there was an overage payment of 50% of the developer's total sales revenue over £7,419,725. Payment and the calculation of the overage was triggered by the sale of the last residential unit.
Planning permission for 84 houses was obtained, but after having completed and sold 80 of the houses for in excess of £9.5 million, the developer did not complete the remaining 4 houses and refused to sell them.
There was no obligation in the Agreement for the developer to build and sell all the houses for which consent was granted, and the Court had to decide whether such a term could be implied. Courts do not readily imply terms into contracts but they appreciated in this case that the developer would only proceed with the development, once planning permission was obtained, if it was going to be profitable to do so, but that if the development was carried out the parties had anticipated that the profits would be shared and that the trigger would be the final sale of a completed residential unit.
Against this background, the court therefore asked itself whether a reasonable addressee of the agreement would understand it to mean that the development could be carried out by the developer, but that he could avoid payment of overage to the seller by failing to complete the final sale, or whether it was to be understood that if the development was carried out the developer would be obliged to complete and sell all the properties.
Luckily for the seller, the Court concluded that a reasonable recipient would not understand that the commercial purpose of the overage provision could be frustrated by "mothballing" the last unit. The Court held that the seller was entitled to specific performance of the developer's implied obligations to proceed to complete the construction and sale of the last few houses, having carried out in the substantial part of the development.
Courts do not however readily imply terms into contracts, particularly between legally advised commercial parties and if the parties had thought through all the "what ifs" at the time they entered into the contract litigation could have been avoided.
When thinking about overage provisions, the parties must consider all the circumstances carefully and in particular:
- the time period during which the overage provisions are to operate, for example does there have to be a change in planning policy before planning permission for a development can be obtained?
- whether a one-off payment is going to satisfy the seller's objectives or whether there need to be several "bites of the cherry";
- what is to be the event triggering the payment, and where the event is not something with a clear date like obtaining planning permission, the event will need careful drafting to ensure it is clear and not capable of abuse. This was the problem in the case discussed above;
- the calculation of any increase in the value of the property and the overage payment and if a complicated formula is used, a worked example should be included to ensure that the formula works and any mistakes are picked up before it is too late;
- when the payment is to be made;
- who is to be bound by the overage obligation; and
- protecting the obligation to make payment, which will normally require the novation of the obligations on "disposal".
Once these details had been thought through, they must be recorded in clear, comprehensive drafting. It is always a good idea to conclude the overage provisions with a good faith clause and perhaps a brief summary of the intention of the parties. A good faith clause may assist the courts to imply terms to an agreement to avoid an unexpected result - without such wording, not all sellers can expect to be as lucky as the claimant in Renewal Leeds Limited v Lowry Properties Limited.