Top Tips for Developers: Negotiating Overage Agreements
In a recent article I explained what overage agreements are, how they are calculated and when they are needed.
My specialism as a commercial property solicitor, is supporting developers who are looking to purchase land and advising them on the most suitable and commercial options. In this article I outline what I believe need to be the top considerations for developers when committing to overage agreements, and how they can best protect their investment.
What is an overage agreement?
To recap, overage (also known as clawback) is a contractual document where a seller of land reserves the right to receive an additional payment after completion, if specified future events increase the value of the land.
Typical triggers include the grant or implementation of planning permission, disposal of property, or reaching certain infrastructure milestones. Sellers use overage to share in future uplift where the sale price at completion does not reflect development potential. However, developers use overage to acquire land for a lower purchase price.
Overage can be simple or highly complex and it is crucial that a commercial property solicitor is involved to consider the legal and commercial aspects of the agreement.
Top seven tips for developers when negotiating overage agreements:
As each land purchase will have its own specific intricacies and potential issues, this is by no means an exhaustive list. However, it should provide any developers looking to purchase a site with some idea of the aspects they and their commercial property solicitor should consider:
Triggers
It is important to define what generates payment to the Seller, known as a “trigger event”. Common triggers include:
- The granting of planning permission – Although it may seem sensible for an overage payment to be triggered when a new or revised planning permission is granted, that permission may never be acted upon. Even where it is implemented, the developer will usually have already incurred significant costs in obtaining the permission. Delaying the overage payment until a set period after the planning permission has been implemented gives the developer time to begin the development and potentially recover some of those costs before the payment becomes due.
- Disposal of Land with or without planning permission – If a developer obtains a new or revised planning permission, and then sells the land without carrying out the development, the landowner will usually want to receive a share of the increase in the land’s value. This is because the planning permission makes the land more valuable, even if the development has not yet started.
Overage Period
The length of an overage agreement will depend on the type of land being sold and the details of the sale. For example, if the land already has detailed planning permission, then a shorter overage period of just one or two years is likely sufficient. If the land does not have planning permission, or it is a larger development site, then a longer overage period of closer to ten years is more common. This is more for the seller’s benefit as it provides them with a better chance of profiting if planning permission is obtained, or the land is redeveloped in the future, substantially increasing its value.
In addition to the above, when agreeing the overage period, developers should also consider extensions for appeals or statutory delays with the local authority, as well as having different periods of overage for different phases of the site to reflect the different phases. There is nothing to say that overage payments need to be in one payment and breaking them down to align with sales will greatly help with cashflow.
Frequency of Trigger Events
If you are buying land for development, it is important to understand how many times you could be required to make an overage payment. Some overage agreements end after the first payment is made, while others remain in place and can be triggered again if certain events occur during the overage period e.g. if another round of planning is approved.
Your commercial property solicitor can explain how the agreement works and help you understand your potential obligations before you commit to the purchase, as well as help to negotiate a better deal on your behalf
Overage Payment Calculation
There are many ways an overage payment can be calculated, and this is arguably the most important term to agree on for a developer. The fees can essentially determine if a development is profitable or commercially unviable. The options are usually:
A) A fixed sum (i.e. the fixed price for the sale of each additional unit)
B) A percentage of uplift in value, which is usually linked to market value (i.e. a valuation on the land and the difference between the agreed “base value” and the revised market value of the land). This will require consideration from an experienced valuer, and the credentials will be set out in the agreement.
If there is a separate calculation, it is important that the calculations are checked to ensure that they work in practice as this will avoid any ambiguity in the future. This is common time for disputes, which can be costly, so this needs to be a clearly documented as possible.
Exceptions to when an overage is payable.
Circumstances may arise where neither party would expect an overage payment in the overage period, even if a disposal is made or a trigger is met. This includes:
- Transferring land to a local authority
- Transferring land as bare land or open space
In these scenarios, a developer and their commercial property solicitor will need to exclude a requirement to make payments when the disposal is made.
Tax implications
Overage payments may trigger tax implications such as VAT, if the land is opted to tax, and Stamp Duty Land Tax (SDLT). It is important that developers are in touch with their tax advisor or accountant at the point in which an overage payment is triggered to ensure all requirements are met.
Awareness and Clarity
Overage agreements are complex documents and it is important that the parties are all aware of their obligations from the outset. Each party should also set out their expectations in the negotiation period to avoid potential disputes when a trigger event has occurred. Property litigation disputes can be both expensive and time consuming, potentially holding up developments by months or even years.
How can GA Solicitors help?
GA solicitors in Plymouth has one of the largest commercial property teams in the city, with decades of experience in the sector. It is also one of the few firms with specialist legal knowledge working with developers on land purchases across the South West and beyond.
If you are a developer looking to purchase development land, then you need to be assured that you have a solicitor who is not only legally knowledgeable, but who also understands the nuances and commerciality of development work.
Call the commercial property team today by calling 01752 203500 or email me directly via lauren.dixon@GAsolicitors.com.
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