“Two recent Court of Appeal decisions have highlighted possible pitfalls in overage arrangements.”

The task of drafting overage provisions has always been onerous. One major concern is to create a regime which covers all eventualities bearing in mind that the overage period may span many years. Such concern is not exclusively for those subject to the overage burden but also applies to those entitled to the benefit of the overage entitlement. Payment of overage even though the desired commercial outcome has not been achieved is a particular worry. Two recent overage cases in the Court of Appeal have highlighted why such general concerns are justified. 

London & Ilford Limited v Sovereign Property Holdings Limited [2018] EWCA Civ 1618 is an example of overage being payable even though the commercial objective of the payer had not been achieved. The overage entitlement of £750,000 in that case was triggered by written notice from the local authority giving its prior approval under the Permitted Development Order to the conversion of the building to a minimum of 60 “Residential Units” from retail outlets and a restaurant on the ground floor and offices on the upper floors. Such a notice of prior approval was given but the problem was that notwithstanding this approval the residential development could not be carried out as it was incompatible with the fire escape provisions of the Building Regulations.

The issue in the case was purely one of construction as no claim was made for either rectification or the implication of a term. The argument was that it was integral to the occurrence of the trigger event that the 60 flats should be capable of being constructed and so in the circumstances no trigger event had occurred. This failed both before Warren J. and the Court of Appeal leaving the claimant having to pay the £750,000 but without the ability to carry out the conversion to flats. 

It serves to emphasise the importance of the formulation of the trigger event. It is a statement of the obvious that the payer’s objective upon the occurrence of the trigger event is that the development is capable of being carried out. The safest course is to define the trigger event by the obtaining of the last of the approvals required to enable the proposed development to proceed. It means that before finalising the overage regime there needs to be undertaken a careful assessment of what hurdles have to be overcome before the proposed development can proceed so as to ensure that all are covered by the overage trigger event.

It may be that the requirements as to prior approval under the Permitted Development Rights regime (in this case those imposed by Class O) encourage the belief that the proposed development would be fully authorised by the prior approval when given. As is shown by the outcome in this case that is not the position and it has to be appreciated and catered for when drafting the overage regime.

In his judgment Lord Justice Richards referred to clause 27.1 in the sale contract which is the standard provision that the buyer has been given the opportunity to inspect and investigate and then materially provides “The Buyer has formed its own view as to the condition of the Property and the suitability of the Property for the Buyer’s purposes.” This led the learned judge to state that the Buyer “was well able to satisfy itself on the viability of the scheme for 60 Residential Units shown in the plan before agreeing to it.” This makes the point that standard clauses are not to be treated lightly and will be of significance.

The repeated extensions of the Permitted Development Regime (“PDR”) mean that when an overage regime is being included in a property transaction relating to a building extra care has to be taken to ensure that the overage regime caters for changes authorised by it and that the operation of the PDR will not defeat or hamper that overage regime. It means that there must be an understanding of the consequences of the application of the PDR to the building and in particular what possible changes of use can be authorised under it and what is required in order to effect a change. 

Burrows Investments Limited v Ward Homes Limited [2015] EWHC 2287 (Ch) concerns the more focused overage issue as to which disposals are permitted whilst the overage regime continues in force. The ability to dispose of parts of the land subject to overage may be important but equally it is important to the person entitled to the overage that such an ability cannot be used to avoid the payment of overage.

In this case the overage payment was linked to completion of a development. To protect the overage entitlement restrictions were imposed on the disposals that could be made pending completion. Prior to any disposal other than a permitted disposal the disponee must enter a direct covenant with the person entitled to the overage. The dispute centred on a sale of five units to a registered social landlord. There were 35 units remaining to be built under the original planning permission but sales had been slow due to the financial crisis in 2008. Consequently, an application was made to revise the permission so that more but smaller units could be built as it was felt that these would be more attractive to buyers. The old section 106 agreement imposed no requirement for affordable houses but the new planning agreement required the provision of five affordable homes to one of a number of specified registered social landlords. The sale of five units to the registered social landlord was in discharge of that planning obligation. The issue in the case was whether this sale was permitted by the terms of the overage regime or was a breach of it because no fresh covenants had been entered into which gave rise to a claim for damages. If the disposal was a breach then there was the further issue as what the measure of damages would be. 

On the first issue it was considered whether the disposal of five units was one of two types of permitted disposals under the overage regime. One type permitted disposals of Individual Market Units in the open market at arm’s length. Initially this was relied on by the developer but on appeal it was conceded that the sale of the five units was not an arm’s length transaction on the open market. The other type of permitted disposal considered was transfers of land for “the site of an electric sub-station gas governor kiosk sewage pumping station and the like or for roads footpaths public open space or other social/community purposes”.

It was argued on behalf of the developer that the transfer to the registered social landlord was a disposal for social/community purposes. The Court of Appeal confirmed that the construction of the overage regime involved the “unitary exercise” of interpretation adopted in cases such as Rainy Sky and Arnold v Britton and more recently Wood v Capita Insurance Services Limited. The developer’s argument failed for two reasons applying the ejusdem generis rule of construction in a flexible manner. First, because this class of permitted disposal was construed as being restricted to transfers of land without a building on it and certainly not a house. Second, the social/community purposes referred to where those akin to the provision of land for roads, footpaths or public open spaces which does not cover affordable houses.

As the transfer of the five houses was not a permitted disposal it was a breach of contract and the second issue was how to assess any damages bearing in mind that no actual loss had been suffered. Before the commencement of proceedings it had been established that on the completion of the development no overage payment fell due under the overage regime. The claimant argued that for the transfer of the five houses to take place without a breach the developer needed to have first obtained the claimant’s consent which would have required a payment. It was, therefore, seeking damages for the lost opportunity to negotiate. At first instance this damages claim failed on the basis that the circumstances fell outside the Wrotham Park principle because the overage entitlement is merely a contractual right and not a proprietary interest. The Court of Appeal rejected this because the developer had freely agreed a restriction on the ability to dispose of the land which had been deliberately broken

Will this decision on the measure of damages withstand the more recent Supreme Court decision in Morris-Garner v One Step (Support) Limited [2018] UKSC 20 which concerned breaches of restrictive covenants taken to protect a business? Lord Reed formulated the important distinction in that context as being: 

“93. In the present context, however, what is important is that the contractual right is of such a kind that its breach can result in an identifiable loss equivalent to the economic value of the right, considered as an asset, even in the absence of any pecuniary losses which are measurable in the ordinary way. That is something which is true of some contractual rights, such as a right to control the use of land, intellectual property or confidential information, but by no means of all. For example, the breach of a non-compete obligation may cause the claimant to suffer pecuniary loss resulting from the wrongful competition, such as a loss of profits and goodwill, which is measurable by conventional means, but in the absence of such loss, it is difficult to see how there could be any other loss.”

He then went on in his judgement to emphasise this by stating amongst his conclusions that

“95(6) Where the claimant's interest in the performance of a contract is purely economic, and he cannot establish that any economic loss has resulted from its breach, the normal inference is that he has not suffered any loss. In that event, he cannot be awarded more than nominal damages.”

As mentioned above in the Burrows case the Court of Appeal placed importance on the contractual restriction on the ability to dispose of the land. Further the developer had initially considered that a disposal of the affordable houses would not be a permitted disposal. As a result the developer had sought to obtain a variation of the overage regime with three months of fruitless negotiations before taking matters into its own hands by going ahead with the disposal. This combined with the contractual restriction on disposal should mean that the decision on the measure of damages holds good. 

Lessons to be learnt 

(i) Background information assists construction but will often not be sufficient to fill in gaps to achieve a result which is commercially sensible but does not fit the contractual wording;

(ii) Drafting an overage regime to apply to a building will require an understanding of the operation of the Permitted Development Rights regime;

(iii) It is important to appreciate that prior approval under the PDR does not mean that the development will necessarily happen;

(iv) All formal obstacles to the carrying out of a proposed development need to be borne in mind and taken into account when formulating the overage trigger event.

(v) If the overage regime includes a general restriction on disposal but with permitted disposals then care needs to be taken that any disposal complies with the terms of the overage regime.

(vi) Failure to do so will result in a damages claim even if no overage falls due under the overage regime.

(vii) Standard clauses in sale contracts are no less important for being standard and can influence the construction of the substantive provisions in the contract.