Overage, or ‘clawback’, is in legal terms a fairly modern concept – at least it has been fashionable for a relatively short period. In that time, though, this promise by developers to pay a future payment to landowners, in addition to the sale price, for the increase in land value once a development has been completed, has acquired a certain mystique.

Partly, this is because it is a classic example of where lawyers are required to reduce to words concepts that are perhaps more effectively dealt with in mathematical formulae. Often (and sensibly) the translation is not attempted, but whatever approach is taken, surveyors and lawyers must work together on overage provisions to ensure that the words and the arithmetic tally. The other complexities stem from making the overage payment secure – and that is truly the stuff of lawyers.

The first issue to consider is the appropriate structure to secure an overage payment. Let us consider a simple scenario. The owner of Brownacre (former industrial land now derelict) wants to retire and is realising his assets. Brownacre is ripe for housing development, subject to clean up and securing planning permission.

The owner finds a buyer but they cannot agree a price that takes into account the hope value and so negotiate an up-front price, plus an amount to be paid based on the uplift in value achieved when the buyer develops.

It is agreed that certain costs (including costs of clean up and securing planning permission) can be deducted before the uplift in value is shared. The covenant to pay the additional payments appears in the transfer of the property. It will, however, be a positive covenant and therefore not enforceable against successors in title to the freehold of Brownacre. This gives the buyer a perfect means to circumvent the payment if it chooses to do so, by transferring the property to a third party.

The corporate buyer has the advantage that the third party can be a subsidiary company (keeping the development profits within the buyer’s group and probably lowering the adverse tax consequences of a disposal). Of course, the integrity of most buyers is such that they do not actively set out to find ways around performing their covenants. However, on a development where profit margins are tight, there may be compelling reasons making a simple let out, that is, a happy accident of law, an attractive proposition for the buyer. The seller must therefore secure the overage payment to protect against such means of defeat.

The seller’s goal is to protect the future payment without scaring off the developer’s funder. Sadly there is no perfect method of security. There are some devices that are now quite familiar (see box p17) but all are flawed. So what are lawyers to do when trying to secure overage? Is it simply a case of making the best of a bad lot and picking whichever of the more common methods seems to be the least problematic at the time? Perhaps. But there is, we suggest, an often overlooked alternative that we have used on many transactions, originally in the public sector but increasingly on private sector deals: a carefully-crafted rentcharge.

Positive obligations do not ‘run with the land’

Leaving the arithmetic and allowable deductions on one side for now, a major difficulty with any overage arrangement is how, in effect, to make positive covenants run with the land. This is something that fits unhappily with English land law.

Rentcharges, backed with an equitable charge and a legal right of re-entry, do not technically make positive covenants run with the land, but they do make the covenants enforceable against the landowner from time to time – a powerful tool.

Modern rentcharges

It might be useful to rehearse some of the key characteristics of a rentcharge because they are fairly uncommon.

Rentcharges are interests in land that are registrable at HM Land Registry in their own right – and, indeed, must be registered to be fully effective. They can be bought and sold; in fact, they can be dealt with in the same way as any other registered land. Historically, rentcharges were used to provide periodic payments out of land in favour of a non-owner. Then came the Rentcharges Act 1977 (the Act). It is a common misconception that the Act abolished rentcharges except to secure service charge-type payments on freehold estates. It did not. Rather, the Act restricted the types of rentcharge that could lawfully be created to:

• the estate rentcharge that secures payments for services for common maintenance facilities used in common by groups of property owners; and

• a nominal rentcharge that secures performance of covenants, typically those that touch and concern land.

Certain trust arrangements and rentcharges required by a court order are also permitted, but they are not relevant for the purposes of this article.

A rentcharge is defined by s1 of the Act as:

… any annual or other periodic sum charged on or issuing out of land, except–

(a) rent reserved by a lease or tenancy, or

(b) any sum payable by way of interest.

Section 2 deals with the limited nature of rentcharges that may now be created and, when using rentcharges as security, the draftsman must be particularly aware of the provisions of that section.

Section 11 of the Act deals with implied covenants on conveyance of land subject to a rentcharge and implies into every such conveyance a covenant in favour of the transferor by the transferee to pay the rentcharge and an indemnity for non-payment/non-performance of the rentcharge. These implied covenants also run with the land.

A rentcharge must be granted in fee simple or for a term of years absolute under the Law of Property Act 1925. Equitable interests can be held in the rentcharge – it might be the subject of a trust for example.

It is only the legal owner of the rentcharge, however, who can enforce payment of the rentcharge.

What can a rentcharge secure and how?

The nominal rentcharge renders positive covenants enforceable against the land even if owned by successors in title and, as such, is potentially a very powerful tool for the development lawyer. A word of warning though: a rentcharge cannot be used to render all types of positive covenant enforceable – if it could it would evade the purposes of the 1977 Act.

Crucially, a covenant just to pay money will not be secured by a rentcharge; a simple covenant to pay cannot be brought within the scope of the Act. If carefully drafted, however, as one of a raft of development obligations, with a promise of an overage payment as part of the whole land transaction, such payment obligations become so entwined with the positive development covenants that they can be brought within the scope of the Act.

Breaches of covenants given to the rentcharge holder can be enforced in many ways.

For instance:

• The rentcharge owner may distrain, which is always difficult, and much less appealing than ever since the Human Rights Act 1998.

• If the instrument creating the rentcharge includes it, the holder will have a power to re-enter and forfeit the developer’s property out of which the rentcharge is given.

Forfeiture in this scenario will operate in much the same way as it does in leases, and so the developer will have a right to relief. That, however, is an equitable right – dependent typically on remedying the breach giving rise to the forfeiture right. The rentcharge owner is interested only in performance of the covenants (including the payment of the overage money) and so that is entirely acceptable.

• Other, more obscure, powers, as set out in s121 of the Law of Property Act 1925, might be invoked. These include the power to appoint trustees to take and distribute the income from the property. These are less likely to be useful, however.

The whole package

It would, naturally, be prudent to create a package of security where possible – particularly where overage is a meaningful part of the consideration for a deal and not mere window dressing or hope value. We therefore recommend backing up the rentcharge with an equitable charge and a legal right of re-entry annexed to it.

Clearly, any security for the overage will need to be negotiated carefully and sensitively with the developer’s funders. Since the rentcharge/equitable charge combination follows the land, it allows for enforcement against the asset that has the value, and not enforcement against a person who may have inherited covenants that they did not originally bargain for.

Moreover the rentcharge/equitable charge is relatively simple to deal with if the developer gets into financial difficulties. It gives the rentcharge owner the right to enter and take possession of the property, and then realise the asset in order to pay off the overage due.

The rentcharge owner does not have to take possession and does not have to take enforcement action immediately upon the developer getting into difficulties. It can wait until the most appropriate time to do so. The rentcharge owner, commercially, does not want to take possession but wants to be paid when the overage payment is triggered. Assuming the funders support the development through to completion and disposal, therefore, the rentcharge owner will be happy to wait for payment out when the trigger event occurs. Of course, the payment triggers themselves will probably also be a keenly negotiated part of the deal – but that is best left for another time.

Conclusion for practitioners

Compared to some of the other, more popular, but often more problematic, methods of securing overage payments, rentcharges have several attractions. Once overlooked as an outdated relic, rentcharges could now come back into fashion as a prominent, and pragmatic, solution for this complex and difficult area.

 © Property Law Journal