The basic element of all of such arrangements is that there is a potential extra payment if specified future events happen or certain circumstances arise. Many deals will involve variable payments, depending on the same or other events or circumstances.
Overage can be calculated in different ways and there are various methods available better to secure or guarantee payment on the future due date.
As with any agreement in principle, the devil is often in the detail and each party has different interests to protect. Overage agreements are sometimes fairly complex and all have pitfalls for the inexperienced or unwary.
In this article I look at some basic contract elements. A later article will look at other things that are important to the payee, being:
- how to limit the scope for the payer to avoid overage becoming due; and
- some methods available to secure or guarantee that any future payments that might become due will actually be paid.
Clear method of calculation
It's crucial that the contract correctly and clearly expresses the method of calculation of the overage payment or payments which might become due. If the extra payment is linked in some way to disposal proceeds set against actual development costs then the contract should leave no doubt as to:
- what receipts are included; and
- what expenses are deducted.
Many contracts include a formula for the calculation. While the use of a formula is a good way to reduce the risk of any ambiguity, those involved should always check that the formula operates correctly to produce the result that they envisage. The best way to do this is to "run the numbers", that is, to try it out using a few worked examples.
It's not uncommon now to see contracts that include worked examples, as a way to demonstrate what was intended by the parties. This is particularly important for any arrangement that might not be triggered for a number of years after the main deal has completed - by which time the personnel involved might have changed or parties' recollections of what had been intended might have faded or some unexpected external circumstance might impact in a way that had never been anticipated. Such "in contract" worked examples can be a failsafe to protect against any ambiguity or unintended consequences of the drafting.
Next, a well drawn document will clearly identify and describe the circumstances or events which shall trigger the obligation to pay the overage. These could include for example:
- the grant of planning permission;
- the occurrence of practical completion or issue of the completion certificate to the local authority;
- a certain number of developed units having been sold; or
- a percentage of the developed property now being occupied or having been let.
If the trigger is the grant of planning permission, then particular issues should be discussed and agreed, including:
- whether overage is only triggered by the first planning consent or whether it remains live (for whatever period) such that it might catch subsequent further consents for any extended or different development;
- should overage only be triggered for a consent for the whole site, or could it kick in on consents for phased development of parts of the site; and
- should the issue of a planning consent only be a trigger once that planning consent is implementable e.g. once all servitudes, sight line agreements, access rights and entitlements to run services have been secured.
Ability of payee to control anything?
Next, a payee might want a degree of control over actions or omissions of the payer - if action or inaction on the payer's part could affect whether or not the trigger events or circumstances arise. For example, a seller might want to oblige a developer buyer to use all reasonable endeavours to obtain the relevant planning consent or to construct and sell the required number of new properties within a particular timeframe.
Such controls might need to include the ability to restrict or require action on the part of successor owners of the land – which would usually mean that those who acquired from the developer would have to enter into a similar contract with the seller.
Payment and longstop dates
If an overage trigger occurs, then the parties should be clear as to how soon after that date the payer must make the overage payment to the payee, and the contract should include provision for interest if the payment is not made on the due date.
And finally, most agreements will include a longstop date, after which overage would no longer be payable even if the relevant trigger events or circumstances arose after that date. The selection of the date is a matter for commercial negotiation between the parties.
So those are the basic elements of an overage or price top up arrangement. As mentioned, I'll discuss "anti-avoidance" methods and how to secure the payment obligation in a later article.