The recent case of Sparks v Biden  EWHC 1994 (Ch) looks at the issue of whether to imply a term into an option agreement to prevent the delay of an overage payment indefinitely.
Mr Sparks granted Mr Biden’s company, Linkwood, an option to purchase land which had the potential for residential development. The benefit of the option agreement was subsequently assigned to Mr Biden.
Under the terms of the option agreement, the buyer was required to apply for and use all reasonable endeavours to obtain planning permission during a three year period. If planning permission was granted, the buyer had one month in which to exercise the option. If the option was exercised, the buyer was then required to proceed to construct the development as soon as practicable.
Planning permission was granted, Mr Biden exercised the option, purchased the land and eight houses were constructed.
In addition to the purchase price for the land, Mr Sparks was entitled to receive an overage payment once any one of the new dwellings was sold, with a total minimum payment of £700,000. Any outstanding balance of the minimum payment became due on the sale of the final dwelling. The option agreement defined a sale as a freehold or long leasehold sale of a dwelling but contained no express term imposing an obligation on the buyer to sell the new dwellings.
Mr Biden occupied one of the newly constructed houses himself and let the remainder under assured shorthold tenancies. Mr Biden argued that by not selling any one of the new houses any obligation to pay overage could be delayed indefinitely. Mr Sparks claimed that a term was to be implied into the option agreement requiring Mr Biden to market and sell each of the new houses as soon as reasonably practicable or within a reasonable period of time of the house being constructed.
The test for implying a term into a contract on the basis of fact was summarised by the Privy Council in BP Refinery (Westernport) Pty Ltd v President, Councillors and Ratepayers of the Shire of Hastings (1977) 52 ALJR 20. For a term to be implied five conditions (which may overlap) must be satisfied:
- it must be reasonable and equitable;
- it must be necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it;
- it must be so obvious that it ‘goes without saying’;
- it must be capable of clear expression;
- it must not contradict any express term of the contract.
The courts’ approach was clarified, rather than reformulated, by the Supreme Court in Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd and another  UKSC 72 where the following comments were added to the summary of principles set out in BP Refinery:
- the first condition may not add anything. If a term satisfies the other conditions, it will be reasonable and equitable;
- only one of conditions two and three needs to be met, they are alternatives;
- another way of phrasing condition two is a term can only be implied if, without the term, the contract would lack commercial or practical coherence. For business efficacy, necessity involves a value judgment;
- when approaching the question of the intention of the parties, the hypothetical answer of notional reasonable people in the position of the parties at the time they were contracting is what matters. The implication of a term is not critically dependent on proof of the parties’ actual intention when negotiating the contract;
- a term should not be implied merely because it appears fair or because the court considers the parties would have agreed it if it had been suggested to them. It is not a test of reasonableness but of necessity.
When is a contractual obligation to be performed? Where a contact does not fix a time for the performance of an obligation the law usually implies an obligation to perform it within a reasonable time.
The court held that a term should be implied into the option agreement obliging the buyer to market and sell each house constructed as part of the development, within a reasonable time of the option having been exercised and a planning permission having been obtained. Without implying the term the option agreement lacked commercial or practical coherence. It was necessary as a matter of business efficacy. Furthermore, the term was so obvious it went without saying.
In reaching this decision the court considered the relevant factual background. Mr Biden was an experienced developer. Mr Sparks was also a businessman but not a developer. It was clear that Mr Sparks intended to benefit personally from the sale (and overage provisions) and that Mr Biden must have known his age and that he had retired or was about to retire.
The court also considered the option agreement and a key factor was its structure. The buyer was under an obligation:
- to use all reasonable endeavours to obtain planning permission during the option period;
- to proceed to construct the development as soon practicable after completion of the sale arising from the exercise of the option; and
- to pay overage, which in principle was triggered once any of the newly constructed dwellings was sold (even if payment was delayed).
The first two obligations must be with a view to realising the value of the development. On a ‘natural reading’ of the option agreement these obligations were directed at bringing about the third, a situation where overage became payable. Having implied a tem requiring the buyer to sell the new houses, the court decided the implied term necessarily must provide a time within which that obligation must be performed.
- The idea of a seller being entitled to an additional payment from a buyer after completion of the transfer of a property, triggered by an event that enhances the value of the property, sounds straightforward. The drafting reality is complicated and rife with pitfalls.
- Developers should be aware that if they seek to frustrate the payment of overage by taking advantage of a loophole in the drafting of an agreement, the courts may be prepared to imply terms to ensure that the detail of the drafting does not allow them to evade liability.
- Sellers should be aware that a developer may try to avoid paying overage by exploiting any gap or inadequacy in the drafting of an agreement. In the absence of an express term in an agreement, the usual inference is that nothing is to happen. Every overage agreement is unique and the courts may not always be prepared to intervene.
- When drafting overage provisions you cannot expect to provide for every anti-avoidance possibility but it is critical to describe very carefully what exactly will trigger the overage payment and the time frame for payment, including an end date at which point the overage will crystallise. If there are any unsold or uncompleted dwellings at the end of an agreed period, overage is payable calculated by reference to a market or notional value.