What is overage?

Lauren Pearson, senior associate in Lodders’ Real Estate group and a specialist in strategic land matters, takes a deep dive into overage agreements and how they work.

Also often referred to as “anti-embarrassment”, “uplift” or “clawback”, overage is a contractual agreement where a land purchaser agrees to pay an additional sum of money (on top of the purchase price) to the seller if a specified event happens in the future to increase the value of the land. This results in the buyer sharing part of this increase in land value with the seller.

Overage agreements are formalised by a contract or deed entered into by the buyer and the seller on completion of the sale of the land.

Overage has become increasingly popular in recent years in line with the increase in property values and ever-changing development prospects. Understandably, overage agreements are popular with sellers as they can maximise potential financial returns. Overage can also be a useful way for buyers to negotiate a lower purchase price on the understanding that an overage agreement will be entered into.

It is crucial for any buyer or seller to understand how an overage may be an appropriate mechanism to be used in any given transaction and, if so, what the terms of the overage should be. What may be appropriate for one transaction may not be for another.

Types of overage

There are several different types of overage. The most commonly used types of overage are as follows:

1. Planning overage: This type of overage means that an overage payment shall be payable once a planning permission has been granted which has increased the value of the relevant land. Following this, the overage payment may be made following (a) the grant of planning permission (b) the planning permission is implemented or (c) the land being sold with the benefit of the planning permission.
2. Turn overage: This type of overage applies where a buyer sells on the land at a profit, without having obtained a planning permission or carrying out any development on the land i.e. they “flip” the land.
3. Sales overage: This type of overage is most used where land has been developed for residential purposes and the revenue from the house sales exceeds the figure which was anticipated prior to the dwellings being sold (the “base figure”). Where a sales overage is used, the overage payment shall become due when the sales proceeds exceed the base figure and may be paid to the seller in stages or in one payment once the last dwelling has been sold.

Whichever type of overage is used, there may be certain agreed deductions from the overage payment calculation. For example, in a planning overage, reasonable costs incurred by the purchaser in obtaining the planning permission which results in an overage payment becoming due may be deducted or, in the case of a sales overage, revenue from affordable housing sales or costs incurred in purchasing part exchange properties may be deducted.

Calculating the overage payment

Occasionally, an overage payment can be a fixed sum which is agreed by the parties when the overage agreement is entered into. More commonly, an overage payment is an agreed percentage of any increase in value or revenue, which may be subject to deductions as mentioned above.

When calculating the overage payment, it is also necessary to consider whether it is possible that the land to be subject to the overage agreement may be promoted for development together with adjoining land which is not subject to the overage agreement. If so, this can have an impact on how the overage payment should be calculated because the increase in value or revenue may be calculated proportionately over the wider area of land to be promoted rather than the land subject to the overage agreement in isolation. This is a principle known as an “equalised overage”.

Ultimately, the calculation of the overage payment, the agreed percentage, and any deductions will be determined by what is negotiated commercially between the buyer and the seller.

Key considerations in an overage agreement

Overage agreements are bespoke and complex documents which require careful thought on a transaction-specific basis. However, some key considerations to be given in the drafting and negotiating include the following:

• The duration of the overage period. Generally, overage agreements can be in force from anywhere from a few years to a few decades. A buyer will want a shorter overage period whilst a seller will want a longer overage period.
• Any types of planning permission which may be excluded from triggering an overage payment. For example, it may be agreed that obtaining a planning permission to construct agricultural buildings or to change the use of land to agricultural or equestrian use should be excluded.
• Whether more than one overage payment can become due and payable or whether the provisions of the overage agreement will fall away after the first overage payment i.e. whether it should be a “rolling overage”.
• Any obligations on the buyer to keep the seller updated on matters such as applying for a new planning permission and any decisions on such applications made by the local planning authority.
• How the overage agreement should be secured. The most commonly used method is a restriction being registered against the buyer’s title to the land at HM Land Registry which shall prevent the buyer from being able to transfer the land without the consent of the seller, which would only be granted upon any overage payment being paid or the new buyer entering into a deed of covenant to comply with the provisions of the overage agreement.
• Any disposals of land subject to the overage agreement which can be made free of the provisions of the overage agreement. For example, on a residential development, it would not be appropriate for each new build dwelling to be sold subject to the provisions of an overage agreement or for an electricity substation to be transferred to the electricity provider subject to the provisions of an overage agreement.
• How any disputes between the parties are to be resolved. Disputes may include the amount of overage payment due. It is common for any dispute to be referred to an independent expert for determination where the parties cannot resolve it between themselves.

It is advisable for both buyer and seller to seek the advice of a specialist land agent on the commercial terms of any overage agreement, including the calculation of the overage payment and valuation mechanism.

Tax considerations

An overage agreement may have tax implications for both the buyer and the seller.

For a seller, overage payments are often taxed on the same basis as the sales proceeds. So, if capital gains tax is payable by the seller on the proceeds from the land, then capital gains tax will be due on any overage payment.

For a buyer, stamp duty land tax will be payable on any overage payments and, if VAT was payable on the initial purchase price, any overage payment will also be liable for VAT. There are mechanisms whereby a buyer can apply to HMRC to defer any stamp duty land tax payments until the overage payment has been calculated and paid.

In either case, the parties to an overage agreement should seek specialist tax advice for advice.

Expert legal advice on overage agreements

Overage agreements can be useful in property sales and be of some benefit to both parties, but they are highly individual to each specific transaction and can be complex. They can be a major source of disagreement between the parties if the drafting has not been pulled together appropriately.

Lodders’ award-winning residential land development team can advise you on overage and ensure your interests are protected.