Such arrangements involve the potential for extra payment(s) if a specified future event or events happen or certain circumstances arise. For example, if land is sold for agricultural use at a price which reflects that use, the purchaser might agree to make a further payment (post acquisition) if planning permission is subsequently obtained for residential or commercial development.
Today, I'm looking at two issues in overage deals that are very important to the seller or payee. Those are:
- how to limit the scope for the buyer or 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.
If an overage agreement is not drafted tightly enough, there can be scope for the payer to engineer circumstances such that either a payment liability is not triggered or the level of payment is much lower than the payee considers is its due. When negotiating such an agreement, the seller must continually ask itself whether the buyer could manipulate the circumstances so as to avoid having to pay up.
Here are just a few banana skin areas and how a seller can avoid slipping up on them:
- Deliberate delay until longstop date has passed - A buyer might delay the start or completion of a development if the trigger for payment is such start or completion.The way to minimise this risk is to oblige the buyer to obtain relevant consents and to develop within a reasonable timeframe - and to provide that if the buyer breaches these duties, this will trigger an obligation to pay overage based on a set of assumptions e.g that development has started or completed.
- Deliberate failure to complete a development - If overage is due on the sale of the last property on a site (e.g. the last house in a residential development), the buyer might try to avoid triggering the liability by leaving a small part undeveloped or the last property unsold. Again the solution could be to impose obligations to use all reasonable endeavours to obtain consents, develop and sell as soon as possible - with a deemed market value disposal being assumed if these duties are breached . This could be supplemented by interim overage triggers, on the sales of batches of developed units - so that the holding back on the sale or development of a few would not avoid the liability.
- Artificial transactions to lower the value - Certain things can lower the value of a land interest, e.g the existence of a lease over it at a rent lower than the market rate or otherwise on terms that are detrimental to the owner. First, the seller could prohibit the buyer from entering into any transaction that was not genuine and negotiated at arm's length. Secondly, the overage calculation could be either the actual disposal price or (if any transactions had been done which reduced the value of the land) the market value, if that was higher than the actual disposal price.
- Inflated deductions - Often, the buyer can deduct certain outlays from the disposal price, in order to calculate the overage amount e.g professional fees and construction costs. It's in the interest of the buyer to maximise deductions. Overage drafting should be clear on exactly what can be deducted - and should limit, where possible, the scope for buyer discretion on spend or the method of vouching spend.
Securing or guaranteeing payment
Sellers who have negotiated an overage entitlement should always consider whether they should rely on the buyer's contractual obligation to pay it (if it becomes due). Sometimes this will be enough e.g. if the buyer is a local authority or some other body that is unlikely to disappear or become unable to pay its debts.
However, if the buyer is an individual or corporate body of some sort, there is always the risk that it might default. So what options are available to the seller?
The two most commonly used methods are:
- taking a security or charge over the site or other land owned by the buyer; or
- requiring the buyer to provide a guarantee or performance bond from a substantial entity.
These solutions are not always available and neither method is 100% effective.
It's not always possible to get a charge over the site being sold - as the buyer often has an external funder, who will want a first ranking security and might prohibit the buyer from granting any other charges.
Even if the buyer will grant a security to the seller, it can be of limited use if overage is payable late in the process. If e.g. overage is due following the sale of the last house, at that point there will be nothing left secured - as the security will have to be lifted from each house as it is sold.
Another difficulty can arise if the buyer becomes insolvent before any obligation to pay overage has been triggered e.g. if it goes into liquidation before it has even commenced development. There are ways to ensure that an obligation to pay crystallises at that point - but you must be alert to the possibility in order to address it in the drafting.
Guarantee or performance bond issues
If there is a suitable guarantor available then this can be a good solution - it is simple to operate and relatively straightforward to document. As with the security route, the seller would want some early trigger of the obligation to pay if the buyer became insolvent.
The main risk with this route is that the guarantor fails or is unable to pay when called upon to do so.
If no adequate covenant guarantor is available, there is the alternative of a performance bond, usually from a bank. However, as these are expensive for buyers to obtain and the terms of them can be fairly restrictive, the bond route is often impractical.