Overage – sometimes called “clawback” or “deferred consideration” – is used in real estate transactions to share increases in value after land has changed hands and allocate financial reward (and risk) between sellers and buyers. In short, overage is a right for a seller to receive additional payment from a buyer if the land purchased subsequently rises in value. For the seller, overage is a means of maintaining an economic interest in land after it has been sold. To the buyer, an overage obligation may be preferable to paying more for the land upfront, based on a hypothetical future uplift in value.
Overage may also be used as an “anti-embarrassment” measure: a public body (with taxpayers and voters to answer to) or a company (with shareholders to please) will not want to be seen to sell land, only for the buyer to turn a quick profit. Overage can provide a solution, by allowing the seller to share the buyer’s financial gain.
Key points to note:
The two key elements of an overage provision are the “trigger event(s)” (to determine when overage will become payable) and the payment formula (to work out how much overage is payable).
(i) The trigger events for payment of overage are usually matters which increase the value of the land or are otherwise of financial benefit to the buyer. Common examples of trigger events include: the grant or implementation of a planning permission; practical completion of a development; or the grant of a lease or agreement for lease. Put simply, when the trigger event occurs, the buyer must pay overage to the seller.
(ii) The amount of overage payable is usually determined using a formula. This will often refer to the increase in market value of the land, or the profit made by the buyer.
There are various other issues to think about when negotiating or reviewing an overage agreement. Most of these are likely to be carefully negotiated by the parties.
- Trigger events are likely to be (at least partly) in the buyer’s control. Accordingly, the seller will want the buyer to take steps to bring the trigger events about. For example, if the trigger event is the grant of planning permission, the buyer may be required to apply for and use reasonable endeavours to obtain the permission.
- The seller will want to ensure that the overage obligation binds a future purchaser of the land. There are various ways in which a seller can secure its overage entitlement. Often, a restriction will be registered against the title of the property, requiring any future purchaser to enter a direct agreement with the (original) seller to comply with the overage agreement.
- The seller may also want additional security for the overage payment – for example, a third-party guarantee for the buyer’s obligations or a charge over the land.
- As demonstrated by the recent case of London & Ilford Ltd v Sovereign Property Holdings Ltd., a court is unlikely to help a developer where a payment trigger occurs, even if the developer does not itself end up benefiting. Accordingly, the buyer will seek to ensure the trigger events are clearly (and, ideally, narrowly) defined, so that overage only becomes payable in limited circumstances. The buyer will also want to set a longstop date, after which the overage obligation expires.
- If the overage is protected by a restriction on title, the buyer should consider the wording of the restriction carefully. Ideally, a buyer will not want the restriction to require the seller’s consent for any onward sale of the land (instead, requiring a conveyancer’s certificate). The buyer may also want to ensure that certain types of disposals (such as granting a lease or charging the property to a lender) are not prohibited by the restriction.
- If the buyer is financing the acquisition, the lender will be wary of a charge over the land securing the overage obligations. Overage arrangements should be discussed with any lender as early in the transaction as possible.
- If overage becomes payable, the buyer may have to pay additional SDLT in respect of the overage amount. The buyer should apply to HMRC to defer the payment.
Whether you are a buyer or a seller negotiating an overage provision, there is plenty to think about to ensure you are adequately protected, so look to your legal advisers and surveyors to talk through the issues involved.