The Potential Pitfalls of Overage

Author: Kate Wilson, Professional Support Lawyer, Real Estate, London

Overage provisions can be complicated, and the recent case of Sparks v Biden [2017] EWHC 1994 (Ch), offers some useful reminders of the potential pitfalls that can arise when drafting overage agreements and the scope of the Court’s ability to imply terms into a contract.  In this article we examine the issues that can arise and suggest some practical points for consideration when negotiating an overage agreement.

In this case, the drafting did not expressly oblige the buyer to market newly built houses for sale once the development was completed, nor was there any mechanism for the payment of overage if the houses failed to sell within an appropriate time. The parties’ intentions were assumed – including that the buyer would want to sell the houses as soon as they were completed in order to realise his investment as quickly as possible.  However, this did not happen, and the agreement did not provide for such a turn of events, leaving the seller at a disadvantage.

  1. Facts of the case
  2. Decision of the court
  3. Points for practice

  1. Facts of the case:

Mr Sparks (seller) granted Mr Biden (buyer) an option to purchase a piece of land which had the potential for residential development. The agreement required Biden to apply for and use all reasonable endeavours to obtain planning permission for the intended development within a three year period and, if the permission was obtained and option exercised, to proceed with the development as soon as practicable.

The option agreement also entitled Sparks to an overage payment with a total minimum payment of £700,000. The obligation on Biden to pay the overage arose on the sale of any of the newly constructed houses, with any outstanding balance of the minimum payment only becoming due on the sale of the final house.

Planning permission was granted and Biden exercised the option and completed the purchase, subsequently constructing eight houses on the land. However, instead of selling the houses, as anticipated by the agreement, Biden occupied one house himself and let the remainder on a short term basis. Biden’s actions highlighted an omission in the drafting of the overage provisions, which contained no express obligation on him to market the houses for sale once development was completed, or any mechanism for the payment of overage if the houses failed to sell within an appropriate time. Consequently, Biden argued that the timing of any sale was completely within his gift, and that any obligation to pay overage could therefore be delayed indefinitely, until he took that decision.

Sparks argued that this interpretation of the option agreement fundamentally undermined the whole purpose of the agreement. He applied to the court for a term to be implied into the agreement, requiring Biden to market and sell each of the newly constructed houses either “as soon as reasonably practicable” or “within a reasonable period of time”.

  1. Decision of the court:

The court held in favour of Sparks. The judge held that a term should be implied into the option agreement, obliging Biden to market and sell each newly constructed house within a reasonable time of the planning permission having been obtained and the option being exercised.

The judge considered that such a clause was necessary as a matter of business efficacy and that without it, the option agreement lacked practical or commercial coherence. Similarly, the clause was, in his view, so obvious that it goes without saying that it should have been included in the agreement (the “officious bystander” test).

The judge made a decree for specific performance, requiring Biden to sell the houses.

  1. Points for Practice:
    • The drafting of overage provisions is hardly ever straightforward, as you are trying to cover every potential outcome of the contractual arrangements in place. It can be tempting, as appears to have happened in this case, to assume the parties’ intentions, and therefore only cater for those eventualities in the drafting. Here, an assumption was made that Biden would want to sell the houses as soon as they were completed in order to realise his investment as quickly as possible. However, this did not happen, and the agreement did not contemplate such a turn of events, leaving Sparks at a disadvantage.
    • Always try to consider as many of the reasonably likely outcomes as possible, and include (for example):
      •    drafting to cover all possible events that could trigger payment of the overage, and the potential for default by one or both parties,
      •    provisions that address a scenario where only part of the development is completed or where additional land is introduced so as to materially change the nature of the development from that originally envisaged,
      •    the potential for a valuation where sales are not achieved within the contractual framework so that the value inherent in the development can be independently assessed and realised.
    • A duty of good faith is often included in such an agreement, although it is questionable as to what this actually means in practice. Full disclosure between the parties both during negotiations and on an ongoing basis whilst the agreement remains in place is also key to identifying, and hopefully avoiding, any potential pitfalls.
    • As you will be aware, a court can imply a term into a contract on the basis of:
      • Usage or custom;
      • The parties’ previous course of dealings;
      • The intention of the parties (a term implied “in fact”);
      • Common law, where the implied term is a necessary part of a particular type of contract; or
      • Statute.
    •    Recent case law has confirmed that the court is often reluctant to imply a term into a contract. Although in this case Sparks was able to convince the judge to do so, there is no guarantee that the court will step in to save the day where the parties have failed to include an express contractual provision to cover an eventuality such as this.

For more information please contact:

Kate Wilson
Kate Wilson
Professional Support Lawyer, Real Estate, London
Email
+44 20 7466 2650

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