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Thursday, 13 January 2011

Overage – Can It Ever Be Future Proof?

What is overage?

Overage is basically the right of someone who is no longer the owner of a piece of land to share in the increased value of that land at some future date. It is often an additional payment that is made to a seller at some time after completion of the transfer of the property (sometimes many years after) and is usually triggered by some event that enhances the value of the property.

In the public sector it is often called “clawback”.

For example, a seller might want to share in future increases in value triggered by the grant or the implementation of planning permission, or take a percentage of future sales following the grant of planning permission.

Perhaps the seller is a farmer selling off bits of land to a developer, and the farmer is only willing to do so if he gets a piece of the action down the line when the developer has built expensive homes and started selling them off. Or maybe an initial sale of land was at a low price to reflect unquantifiable problems such as contamination or something nasty on the title. If curing the problem turns out not to be as expensive as first feared then the seller might want to take a share of increases in value or sale-on proceeds.

Sometimes it might just be “icing on the cake”, the seller will add it on to the terms if it can get away with it.

In the public sector, there may be political reasons why a local authority or government organisation might want to claw back some of the value of land it has sold. If such an organisation sells public property to the private sector and that land subsequently shoots up in value, it will not want to be seen by the voters to have sold it too cheaply, and such bodies have to think of their fiduciary duties to the public as well. In those circumstances it is common for the organisation to try and get a share in future value.

So what will be the trigger that makes overage payable? This is where the seller and its advisers need to try and see into the future and predict what will happen to the land that so enhances its value that the seller can ask for more money. It often calls for some complex and creative drafting of contracts, but a seller needs to be careful that the costs of doing all that don’t outweigh any future gains. It can sometimes be an expensive guessing game.

Can overage ever be future proof?

No, not really. That oft-quoted distillation of profound philosophical truth made by Donald Rumsfeld in 2002 illustrates the problem:

“There are known knowns; there are things we know we know.
We also know there are known unknowns; that is to say we know there are some things we do not know.
But there are also unknown unknowns – the ones we don't know we don't know

That is not to say overage is a weapon of mass destruction, although I once received an overage clause about 30 pages long which certainly had a pretty devastating impact on my mood that day (and “blew the bloody doors off” any hopes my client may have had to get the deal done quickly).

We can try and deal with all the “known unknowns” we can think of, like whether planning permission will be granted for something juicy, or whether it will be implemented, or whether the market will go through the stratosphere. These are circumstances or outcomes that are known to be possible, but we don’t know whether or not they will take place.

But what about the “unknown unknowns”, the things we haven’t conceived of when we sell the land? Or to put it another way, the things the client will probably expect you to have known but which no sentient being could realistically have predicted!

There was a case in 2010 which illustrated the “Rumsfeldian Overage Trap”, as no one is calling it. In Hildron Finance Ltd v Sunley  Holdings Ltd [2010] EWHC 1681 (Ch) a company failed in its claim under an overage agreement to a share in the proceeds of sale of a flat because the sale was triggered by a long leaseholder excercising its statutory right to acquire the freehold, and not by a sale on the open market, which is what the overage clause in the sale agreement provided for. The agreement had been entered into in 1986, but it wasn’t until 1993 that the law was changed giving the leaseholder the right to acquire the freehold. How could the seller’s advisers have known, in 1986, that the law would be changed in 1993 which would then lead to a situation in which the overage clause was basically “frustrated”, as the court held?

The lesson is that you cannot, unless you are a Timelord (in which case I would venture to suggest you should probably have more interesting things to be doing), draft overage agreements to cover all future possibilities.

Any practical tips (apart from investing in a TARDIS)?

Try not to make the overage period too long. The greater the length of time, the more risk there is of an “unknown unknown” materialising.

Throw in as many triggers for payment as you can think of, whilst being realistic and staying within the bounds of reason and sanity.

If it all seems too difficult, forget about it altogether and try and put the price up. Although, given the way things are at the moment, to do that you might need the gift of time travel.

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