At their most basic, overage provisions impose obligations upon a purchaser to pay further sums to the seller to reflect either (or both) planning permission or sale proceeds, which are better than those envisaged at the point of sale. They can also be used as a tool to compensate a landowner for accepting a lower up-front price in return for effectively participating in the future 'upside' achieved by a developer.

Overage becomes particularly prevalent in recessionary times, reflecting developers' lack of liquidity, and landowners' concerns that by selling at the bottom of the market they would be missing out in future growth. Ironically in our rising markets landowners find themselves with a similar dilemma and are anxious that they secure some share in price inflation and benefit from a more benign planning environment. In this article we explain the complexities of calculating overage and why you can't afford to 'get it wrong'.

Overage calculations

There are endless permutations in overage calculations. The more complex the arrangements the more interference in development and marketing by the landowner. Some overage provisions become the main focus of negotiation, morphing a straight forward sale contract into something approaching a joint venture. In any commercial negotiations at heads of terms stage the principles of overage need to be agreed and fully understood by both parties. Although it may seem like a very dull topic, security arrangements, the 'escape route' to facilitate sales, and security release need to be carefully planned.

Too often the overage calculations become so complicated that they become unintelligible. Worked examples, and ideally working spread sheets annexed with a CD, should leave no room for doubt. Current cases show that the Court will have little sympathy for sophisticated and well advised developers and landowners who simply 'get it wrong'.

The twist and turns that you draft and accept will depend upon whether you are the purchaser, or the seller seeking to maintain a long term interest. As a purchaser paying a full purchase price your first stance would be to resist overage completely. This would especially be the case where your price is based on a market valuation which takes account of revenue and planning potential. Overage in those circumstances could effectively amount to the seller being overpaid and getting extra benefit without risk. Public bodies will be especially anxious to secure overage so that they show that they have obtained best value. Sometimes overage is referred to as 'anti-embarrassment payments' - the landowner seeking comfort they have not undersold.

Overage will generally take two forms. Planning Overage, which will provide for additional payment in the event that subsequent permissions are obtained, and Sales Overage which will be calculated according to the sale proceeds that are achieved.

Planning Overage

Planning Overage will generally be paid based on a fixed pound per square foot, unit or room basis. Developers can be expected to seek to deduct any costs of obtaining the further permission and any additional CIL or Section 106 costs arising from the new permission.

On larger schemes where areas previously unallocated for development (and which have effectively been purchased for nil value) become developable, the planning overage may be based on a market value of the new developable land. If so, then any developer should be careful to ensure that the value is not inflated by intervening development that has been carried out - by making sure that any such development is disregarded. Developers will also be keen to ensure that they do not accidentally have a liability to 'double pay' where they have successive new permissions. They will also seek to delay any additional payment by ensuring that overage only becomes due when a planning permission cannot be challenged. Ideally it will be delayed until the permission is actually actively implemented, or at the very least when all reserved matter are approved.

Sales Overage

Sales Overage is always hard fought over and the calculation of exactly what is subject to overage is important. Developers will look to deduct planning overage, (so that there is no double counting), costs of marketing and sales incentives. Landowners will be seeking to cap those costs as a percentage of proceeds received and require firm evidence of these items, through invoices and CML certificates on sale.

The overage will be payable as a percentage of Sales Proceeds received over a predetermined level. That figure could be calculated as an aggregate of proceeds or on an average pound per square foot basis. Either way, there is likely to be indexation of the base value to reflect inflation and cushion against build cost inflation. Care has to be taken about what is included in your measurements – inclusion of garages and balconies for example can massively decrease average square foot return. You will also need to consider what Sale Proceeds comprise – what about freehold reversion receipts and affordable housing or example and will overage apply only to plot sales equally if the site is turned pre development?

Landowners will always be keen to ensure that the overage cannot be avoided by underselling or failing to sell all units at arms length - or at all! Good faith and anti-avoidance provisions will abound along with obligations to build and market in a timely fashion. The larger the sale overage the more interference the landowner will require in the development and sale process to protect its future asset.

As always timing is everything- all parties will need to be clear when the overage is payable and when it is not.

Security for payments and security release

Finally – the biggest bug bear in all overage negotiations is security for payments and security release. Overage will usually be protected by a restriction on title. The key point is that a developer will need to able to ensure that the restriction can be released where overage obligations have been satisfied or do not apply to particular transactions and that in those circumstances the overage obligations do not pass to the new owners. This is obviously important in relation to plot sales – but also section 106 transfer and transfers of affordable housing.

All this is just a taste of what needs to be considered in a world where landowners are keener than ever to ensure that, despite the fact they have sold their asset, they still take a share of the future returns in a rising market.