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Overage (or ‘clawback’) is a promise by a developer to make a future
payment to a seller, so that an additional amount is paid to cover the
increase in land value once the development has been completed. This
relatively simple proposition does, however, raise difficult land law issues.
For instance, suppose the owner of a brownfield site agrees a basic price
with a developer, plus an amount to be paid based on the uplift in value
when the buyer develops. It is agreed that certain costs (eg clean-up and
securing planning permission) are to be deducted before the uplift in value
is shared. The covenant to pay the additional payments will appear in the
transfer of the property. It will, however, be a positive covenant – and
therefore not enforceable against the buyer’s successors in title. This gives
the buyer a perfect means to circumvent the payment if he chooses (ie by
transferring the property to a third party – such as a subsidiary company).
It is this inherent problem with the enforceability of positive covenants that
gives rise to so many alternative structures when negotiating overage
payments. A further complication, of course, is that the seller’s goal in
protecting his entitlement to the future payment has to be achieved without
scaring off the developer’s funder (who will not want to give up his basic
rights of security). In an attempt to solve this problem there tend to be
variations on the following themes:
- options: options (and reverse options) are typically only suitable for fairly short-term arrangements. Options cannot make positive covenants
enforceable against the land. There will still need to be a chain of
covenants between the successive landowners confirming that they will
observe and perform the covenant obligations, and there is no way in
English law of compelling a successor to enter into such covenants;
- charges: a charge will often be taken over the property. There are many
difficulties, and it is essential to make sure that the charge cannot be
redeemed or discharged before the overage payment is due. But, once the
legal date for redemption has passed, the buyer can redeem and redemption
will then be at the current value of the right to receive future payments (ie
which will not adequately compensate the seller in many cases). However,
if the arrangements are relatively short term, it should be possible to
postpone the redemption date until after the date when overage payments
are likely to have been made, or a specific trigger date has passed. This will
work if there is to be only one overage payment but not if there are to be
several (eg following various triggers that enhance the value of the property).
In addition there are likely to be negotiation problems given that overage is
complex and therefore typically arises only on large and complicated deals.
Most such transactions are funded and the buyer’s funder will want the first
legal charge (which he will not get if the seller already has one protecting the
overage). In addition there can be problems with the enforcement of a charge
if the overage payment has not become due; this is especially a problem if
the buyer giving the overage covenant becomes insolvent (eg Groveholt
[2005], where an overage payment was defeated on insolvency);
- restrictive covenants: the difficulty here is that any restrictive covenant is
vulnerable to an application for its release on modification (under s84
LPA 1925). In addition, for a covenant to be enforceable, the seller will
have to retain land that can benefit from the restrictive covenant. Lease
structures are sometimes used, but again these are not suitable for all types of transactions and will typically still be based on the restrictive
covenant device. If the arrangements are to last for a long time (more
than 25 years), then s84 can still be a problem. In addition, L&T
legislation may cause problems if the overage payment is linked to
covenants about alterations and improvements;
- rentcharges: this is another possibility (see the following note for pros
and cons).
For further information see excellent introductory article in [2006] 171
Property Law Journal 15.
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July 2006 |
