A long-running overage dispute has been determined by the House of Lords. An agreement between a landowner and a developer for the development of a block of flats provided for the landowner to receive a price comprising a fixed amount per square foot, together with a balancing payment. The balancing payment, described by the agreement as an "Additional Residential Payment", was defined as

23.4% of the price achieved for each Residential Unit in excess of the Minimum Guaranteed Residential Unit Value less the Costs and Incentives.

The landowner argued that it was entitled to the Minimum Guaranteed Residential Unit Value (this was calculated by reference to the fixed per square foot figure), plus a 23.4% share of the amount by which the net proceeds of sale of each flat exceeded that minimum guaranteed amount. The landowner's interpretation found favour with both the High Court and the Court of Appeal.

The House of Lords thought that this construction was certainly in accordance with conventional syntax. However, it was also bound to throw up a substantial extra payment. At the time of the agreement it was expected that a 700 square foot flat would fetch about £200,000. The minimum guaranteed amount for that flat was just £53,438. Unless the property market fell catastrophically, the landowner would be certain of receiving an additional payment under its interpretation of the formula.

The developer argued that the purpose of dividing the price into the two elements was to give the landowner a minimum price for its land, calculated on current market assumptions, and to allow for the possibility of an increase if the market rose and the flats sold for more than expected. Its case was that the landowner was to receive either 23.4% of the net proceeds of sale of a flat, or the minimum guaranteed amount, whichever was the greater. On this interpretation, there would only be a balancing payment if 23.4% of the net sales proceeds of a flat exceeded the minimum amount. In other words, on the developer's interpretation the clause should have read:

the amount by which 23.4% of the price achieved for each Residential Unit is in excess of the Minimum Guaranteed Residential Unit Value less the Costs and Incentives.

The difference between the two interpretations amounted to over £3.5 million.

The developer's case was put in two ways. First, it argued that the clause should be construed in the manner it contended. In the alternative, it argued that the clause should be rectified so as to give it this effect.

The House of Lords emphasised that it did not easily accept that people have made linguistic mistakes, particularly in formal documents, but said that in some cases the context and background would drive a court to the conclusion that "something must have gone wrong with the language".

The House of Lords ruled that to interpret the definition of Additional Residential Payment in accordance with ordinary rules of syntax made no commercial sense. The term "Minimum Guaranteed Residential Unit Value" strongly suggested that it was to be a guaranteed minimum payment. This connoted the possibility of a larger payment which, depending upon some contingency, may or may not fall due. The element of contingency was reinforced by other provisions in the agreement, which referred to the "date of payment if any of the [Additional Residential Payment]" (emphasis added).

The High Court had declined to give any weight to the choice of words used in the term "Minimum Guaranteed Residential Unit Value", because it was a defined expression. It thought that, by using a special definition, the defined word or phrase was "stripped of its natural meaning". The House of Lords disagreed, saying that the words used as labels are seldom arbitrary. They are usually chosen as a distillation of the meaning of a concept intended to be more precisely stated in the definition. The language of the defined expression may help to elucidate ambiguities in the definition or other parts of the agreement.

On the landowner's construction, there was virtually no element of contingency at all. An additional payment would be made in every case in which a flat sold for more than £53,438. The landowner submitted that that was still a contingency. However, the House of Lords pointed out that if the parties were wanting to cater for an extraordinary fall in the market against which the landowner was to be protected, £53,438 seemed a rather arbitrary figure.

The House of Lords did not think that it was necessary to compare the language of the court's interpretation with that of the original definition in order to see how much use of "red ink" was involved. There was no limit to the amount of rearrangement or correction which the court is allowed. All that is required is that it should be clear that something has gone wrong with the language and that it should be clear what a reasonable person would have understood the parties to have meant. The court ruled that both of these requirements were satisfied in this case.

Importantly, the House of Lords unanimously re-affirmed the well-established rule that pre-contractual negotiations cannot normally be taken into account when a court is construing a document. The court therefore reached its decision on the correct interpretation of the definition without relying on any of the pre-contractual documentation. However, pre-contractual negotiations can be taken into account in a claim for rectification. Although not strictly necessary given its conclusion on the proper construction of the document, the court also examined the developer's case founded in rectification.

The court reviewed the terms of a letter from the developer setting out the key terms of the deal, which supported the developer's position. The court held that these terms were accepted by the landowner. It followed that if (contrary to the finding of the House of Lords) the trial judge was right in his interpretation of the definition, both parties were mistaken in thinking that it reflected their prior consensus, and the developer was entitled to rectification.

Things to consider

Overage clauses can be complex to draft. Specialist legal advice should always be sought.

When using formulae in documents, it is always a good idea to express a formula both algebraically and in words, and to include a worked example using figures which are a realistic estimate of the likely final numbers. This should bring out any differences between the parties' understandings of how the clause is intended to work.

The other interesting point arising out of this case is that the court will have regard to the label used for a defined term when interpreting the definition itself (e.g. "Minimum Guaranteed Unit Value" connotes a minimum value which is guaranteed). Previously it had been thought that virtually any word could be used as the label, since what mattered was how that term was defined. Parties must now take extra care in the labels chosen to represent their definitions. It is important to keep the list of defined terms under review as negotiations progress to ensure that the label itself, as well as its definition, reflects the final commercial deal. It is not clear to what extent the court would be able to take account of the labels used for definitions if the document contains a provision that headings do not affect interpretation.

Chartbrook Ltd v Persimmon Homes Ltd