Overage and contractual interpretation: a round-up of recent cases
March 2019 | SPOTLIGHT | LITIGATION & DISPUTE RESOLUTION
Financier Worldwide Magazine
March 2019 Issue
In recent years, contractual interpretation, and, in particular, the interpretation and operation of overage agreements, has prompted several high profile disputes.
Overage payments are frequently negotiated and are payable to sellers if and when certain conditions are met, usually in the context of a development deal. Typically, overage agreements arise where a landowner wishes to sell land at its current value, but also wishes to participate in any profit that may be realised at a later date, for example when planning permission is granted, or the land is redeveloped.
Although overage agreements are very common, they are always particular to their own facts and are often complex. That is because, when drafting, it is extremely difficult to cater for all future events, for parties with changing and potentially conflicting interests and to cover all possible eventualities.
In this round-up, we take a look at how recent cases have continued to develop the correct approach to contractual interpretation, and what practical lessons can be learned in the overage and development agreement context.
Sparks v. Biden – familiar facts and a cautionary case
Sparks v. Biden arose from a very familiar factual scenario. The landowner, Mr Sparks, granted the experienced developer, Mr Biden, an option to purchase land which had the potential for residential development. The agreement required Mr Biden to apply for and use all reasonable endeavours to obtain planning permission and then, if the option was exercised, develop the land as soon as practicable. The agreement also included an obligation on Mr Biden to pay an overage sum of a minimum of £700,000 on the sale of any of the newly constructed homes.
The developer obtained planning permission, exercised the option and constructed eight homes. Instead of selling them and paying overage, however, he moved into one of the houses and retained the others as investment properties. Mr Biden thereby took advantage of an omission in the overage provisions of an obligation to market and sell the properties once constructed or of any obligation to pay the overage if the houses failed to sell within an appropriate time.
Mr Biden’s argument was that the overage provision gave him complete discretion as to whether and when to sell the properties and, therefore, whether and when to pay the overage. According to the contractual documentation, he was right.
Mr Sparks’ only option was to ask the High Court to imply terms into the overage agreement to overcome the omissions in the drafting.
Convincing a court to imply terms into a contract, in particular a commercial contract that has been negotiated between commercially experienced or sophisticated parties and/or parties who have been legally advised, is not easy. The leading case of M&S v. BNP Paribas confirmed that, because the implication of terms into commercial contracts is potentially intrusive, terms will not be implied lightly. In order for a term to be implied, it must be necessary to give business efficacy to the contract. That is a high bar which asks whether, without the term, the contract simply does not work. However, when deciding whether or not to imply a term, the court will consider the presumed intention of the parties, and what matters is the hypothetical approach of reasonable people in the position of the parties at the time the contract was made.
Applying that approach in Sparks v. Biden, the High Court ultimately decided that an obligation on the developer to market and sell each of the houses within a reasonable time should be implied into the overage agreement. The court took into account the fact that Mr Sparks was not an experienced developer, whereas Mr Biden was, and he was of retirement age and clearly intended to benefit financially and all-but imminently from the overage arrangement.
Mr Sparks was lucky. It is easy to see that if either the particular facts or the overall structure of the overage agreement had been at all different, the case could have gone the other way. While the outcome in this particular case was probably morally correct, and the law on implying terms does contain just enough ‘wiggle room’ to allow the court to legitimately reach the decision that it did, nine times out of 10 a case like this would result in the opposite outcome.
Gaia Ventures v. Abbeygate Helical (Leisure Plaza) – reasonable endeavours?
Mr Justice Norris neatly summed up the crux of this case in the first paragraph of his judgment when he asked: “[h]ow hard do you have to work to make yourself liable to pay £1.4m?”
The case centred on whether a developer complied with its contractual obligations to satisfy certain conditions, upon the fulfilment of which it would become liable to make an overage payment of £1.4m.
The project involved a network of complex transactional agreements. The developer’s obligation to use reasonable endeavours to bring about satisfaction of conditions which would result in overage becoming payable was only one small part of the overall contractual arrangements. For no doubt entirely proper commercial reasons, the developer retained considerable influence over those arrangements – not least so as to ensure that the final development would fund all underlying transactions. However, there was, inevitably, a tension between the flexibility and control that the developer had retained for itself on the one hand, and its obligations to deliver an overage payment liability on the other.
When the requisite conditions were eventually satisfied – some four days after the longstop date had passed (and any contingent liability to pay overage had been extinguished) – the landowner sued the developer, alleging breach of the overage obligations.
The High Court had to decide whether the developer had used “reasonable endeavours” to achieve satisfaction of the relevant conditions “as soon as reasonably practicable”. To do this, the court took into account that an obligation to use reasonable endeavours requires a party to take just one out of what may be many reasonable courses, compared with an obligation to take all possible reasonable courses. It also noted the fact that some of the developer’s actions were taken at times which were convenient for it or suited its funds flow, whereas others were deliberately taken late with a view to avoiding overage liability.
The High Court decided that the developer was in breach of its obligations, and that damages in respect of the overage payment, plus interest, plus costs should be paid to the landowner.
London & Ilford Ltd v. Sovereign Property Holdings Ltd – correct approach to contractual interpretation
Authorities, in recent years, have confirmed that a literal approach to contractual interpretation is to be preferred over a more purposive approach, wherever possible. However, there may sometimes be provisions in even a detailed, professionally drawn contract which lack clarity. A court interpreting such provisions may take into account the factual matrix to ascertain the objective meaning.
In this case the overage agreement provided that the developer would pay £750,000 to the landowner upon receipt of prior approval from the local planning authority for the development of 60 residential units. ‘Development’ was defined as “Change of use…to a use falling within Class C3 (dwellinghouses)” and ‘residential units’ were defined as “Dwellings to be comprised in a development…for residential use for sale or lettings”. Planning approval was obtained, but the 60 units could not be lawfully built because it transpired that would contravene buildings regulations. The developer argued, in reliance on the wording “Dwellings…for residential use for sale or lettings”, that the purpose of the overage agreement was to provide a commercially viable benefit in exchange for the £750,000 payment, and that, in light of the building regulations issue, that benefit had not been provided and the payment was not due.
The Court of Appeal disagreed. Finding for the landowner, the court confirmed that the regime for planning consent was entirely separate from the building regulations regime. There was no mention in the overage agreement of compliance with building regulations or any other such requirement and it had been entered into between two sophisticated developers who were professionally advised. The developer’s attempt to rely on a commercially-focused, purposive approach to interpretation of the overage provisions was “impossibly weak”. The developer, therefore, had to pay out £750,000 and was unable to develop the scheme as planned.
Comment and practical advice
The job of the real estate lawyer instructed to draft an overage agreement is a difficult one. The lawyer has to look past the amicable relations, the apparent common interest and the presumed easy ‘win/win’ of an overage outcome. He or she has to closely probe and predict each party’s ultimate, and potentially changing interests and intentions, even anticipating eventual underhand tactics and future ‘worst case’ scenarios – and then to cater for them in the drafting, which can be very complex.
Bearing in mind the correct approach to contractual interpretation, and in particular, how difficult it is today to depart from the wording of a contract or to imply terms, it is essential that the drafting is clear and comprehensive.
When entering into overage arrangements, parties and their lawyers should carefully consider what exactly will trigger overage payments and they should spell that out precisely. Ideally, provisions should include clear and specific timescales within which detailed conditions are to be met, obligations are to arise and payments are to be made. Consideration should be given as to whether formulas for ascertaining any values and longstop dates and mechanisms for enforcing obligations and resolving disputes should be included.
The London & Ilford case also specifically highlights the fact that developers may prefer to ensure that payments do not fall due until, say, implementation of a planning permission or disposal of the completed units, and that developers’ conveyancers should, depending on the extent of their instructions or retainer, be careful to ensure that they obtain clear instructions and draft accordingly if they are to avoid potential professional negligence liability.
Martin McKeague and Will Cousins are partners at Walker Morris LLP. Mr McKeague can be contacted on +44 (0)113 283 2557 or by email: email@example.com. Mr Cousins can be contacted on +44 (0)113 283 4462 or by email: firstname.lastname@example.org.
© Financier Worldwide
Martin McKeague and Will Cousins
Walker Morris LLP