If you’re thinking of selling some land, you might want to give additional thought to its eventual use, as in the future it might yet provide you with an additional income long after the ink has dried on the sale contract.
Within the land sale contract, it is possible for a seller to establish a right to a future payment if a relevant trigger event occurs.
These rights are known as Overage Covenants, clawback provisions or development covenants and will need to be set out in the sale documentation.
The variety of issues involved means that Overage Covenants can represent a potentially difficult issue for buyers and sellers of land.
What is Overage?
In essence, Overage Covenants provide that a further payment will become due to the seller in the event of certain trigger events taking place within a defined period after completion of a land sale.
As the UK needs to build 250,000 houses each year to meet current housing demand, sellers of land should consider whether there is potential for the land to be re-developed in the foreseeable future. Where there is some development potential, sellers ought to consider protecting their position by seeking to impose an Overage Provision because otherwise the seller may feel they have missed out on a higher sale price if the value of the land subsequently increases.
What might constitute a trigger event?
A simple version of an Overage Covenant might state that a further fixed sum would be payable for each additional dwelling built on the land. There are, however, numerous different forms of wording, some of which rely on a more complex valuation mechanism to calculate the additional payment.
For example, a seller and a buyer might agree that if the land is developed within 25 years of completion of the sale then the buyer will pay to the seller 50% of the increase in value of the land as a result of the development.
There are a number of different points for the parties to agree, for instance the time period, what type(s) of development will trigger a payment, whether the payment is a fixed amount or a variable sum and, if so, how exactly the increase in value is to be calculated.
As a result, the legal drafting surrounding this type of provision is often complex and will increase the costs of the transaction for both parties.
Issues to consider for Overage Covenants for sellers
Sellers and buyers will need adequate protection for a number of reasons:
For sellers, it is important to remember that the seller will have no control over whether or not any development takes place; therefore there is no guarantee that any further payment will ever become due.
Furthermore, it is important to provide that in the event that the land is sold on again during the payment period then the successors in title to the original buyer should also be bound to make payments in the event that they develop the land.
Sellers will always need to consider what mechanisms are available to them to ensure that they receive notice of any development of the land and therefore they are in a position to claim the further payment.
Issues to consider for Overage Covenants for buyers
For buyers, the critical issues include looking to ensure that the land can still be dealt with as freely as possible in the future – as such, buyers will want to avoid clauses that are overly restrictive of their ability to sell or lease the land.
Buyers should also bear in mind that if they did look to sell the land it may be that a buyer would be reliant on bank lending in order to finance the purchase; in those circumstances, bank lenders will be concerned to check that the Overage Covenant does not adversely affect their security, and therefore it is important to check the terms of the Overage Covenant carefully for any points which might raise difficulties for future funders.
There can also be complications for buyers in terms of Stamp Duty Land Tax.
Who else might be affected by Overage Covenants?
A third class of persons affected by Overage Covenants are those who buy land that is already subject to pre-existing Overage Covenants.
It is vital that a buyer of land in these circumstances should understand the nature of the agreement that was put in place by their predecessors in title, and how this could affect their proposed use of the land.
Again, there can be Stamp Duty Land Tax considerations for a buyer of land in these circumstances.
Calculating Overage payments
All parties will need to bear in mind that there can be some uncertainty inherent in the calculation of the amount of overage payments where this involves carrying out a valuation of the land as it stood immediately before the development, and then a separate valuation as a result of the development taking place.
Given that valuation is not always straightforward, there may be scope for differences of opinion as to one or both elements of this equation.
Most overage provisions contain a process for an expert valuer to be appointed if the parties cannot agree on the relevant figures to be used, but there is no guarantee for either party that a valuer will find in their favour.
Seek legal advice early if you’re considering Overage Covenants
As with so many of the potential issues that can arise on sales of land, all parties need to ensure that they understand the issues and consider any risks.
Obtaining specialist advice as early as possible in the process can place a party in the best possible position to negotiate favourable terms going forward.
Tallents’ commercial property department has experience in advising sellers, buyers and subsequent purchasers in relation to Overage Covenants. In the event of a dispute then our specialist litigation solicitors can help guide clients through the process.
For more information please contact Tom Gibbons on 01636 671881.