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Overage and implied terms: Caution required!

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06/02/2018

The recent High Court case of Sparks v Biden [1] has emphasised that overage provisions can be particularly tricky.  Walker Morris partners Will Cousins and Martin McKeague explain and offer their practical advice.

Overage and traps for the unwary

Overage payments are frequently negotiated to become payable to landowners/sellers on or after completion, 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 in future, or the land is redeveloped.

Although overage agreements are very common, they are always particular to their own facts and they are often complex and fraught with risk. That is because it is notoriously tricky to cater in the drafting for unknown future events; for parties with changing and potentially conflicting interests; and to cover all possible eventualities.

Common scenario

The recent case of Sparks v Biden has highlighted some of the key issues of which landowners/sellers, buyers/developers and their professional advisers should be aware.

In what is a very common scenario, the landowner, Mr Sparks, granted Mr Biden, an experienced developer, 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, to develop the land as soon as practicable.  The agreement also included an obligation on Mr Biden to pay an overage sum (calculated in accordance with a formula but with a minimum payment of £700,000) on the sale of any of the newly constructed homes, with any outstanding balance of the minimum sum to be payable on the sale of the final property.

Following the grant of planning permission, Mr Biden exercised the option, bought the land and constructed eight homes. Instead of selling them and paying overage, however, he moved into one of the houses himself and retained and let the others as investment properties.  In doing so, Mr Biden took advantage of an omission in the overage provisions of an obligation to market and sell the properties once constructed or any obligation to pay the overage if the houses failed to sell within an appropriate time.

Mr Biden’s position 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 the contractual documentation, he was right.

As a landowner who stood to make a significant financial loss, Mr Sparks’ only option was to ask the High Court to imply terms into the overage agreement to overcome the omissions in the drafting.

Implying terms – an uphill struggle

As Walker Morris has reported previously [2], 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 – at all.  In fact, it is trite law that the court will not step in to correct what may have turned out to be a ‘bad bargain’ between parties.

The recent 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. Underpinning this are the concepts of ‘freedom of contract’ and ‘contract is king’, both of which are crucial to English commercial contract law.

In order for a term to be implied, it must be necessary to give business efficacy to the contract. The test is a high bar which asks whether, without the term, the contract simply does not work.  Where the parties have entered into a formal contract, especially where they have been legally advised, it will be particularly difficult to imply any term(s) as it will be doubtful whether any omission was the result of the parties’ oversight or a deliberate decision.  In addition, for a term to be implied, it must be obvious; capable of clear expression; and must not contradict any express term of the contract.

All of these factors mean that, in practice, courts rarely ‘interfere’ to imply terms.

However, in M&S v BNP Paribas the Supreme Court also held that, when deciding whether or not to imply a term the court will consider the presumed intention of the parties, and that what matters is the hypothetical approach of reasonable people in the position of the parties at the time the contract was made.

Cautionary case

Applying the M&S v BNP Paribas approach to the facts of this case, 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 judge considered that, on a natural reading of the contract as a whole, the arrangement was directed towards bringing about a situation where overage would become payable. It held that implying terms to make that happen within a reasonable time was necessary as a matter of business efficacy and was so obvious as to go without saying.

The court took into account the fact that, while Mr Sparks, the seller, was a businessman, he 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.

It is easy to see, however, 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.

Because of the developer’s conduct in resisting the sale of the houses to date, the court also took the relatively rare step of making an order for specific performance. That is an order, which the court will police and enforce, to compel a party to perform the requisite contractual obligations.  (However the judge adjourned the precise working out of the order to a subsequent case management conference, acknowledging the difficulties that could be involved in drafting appropriate mechanisms for the marketing and timing of the sale of each of the properties.)

WM Comment and practical advice

he outcome in this case is probably morally correct on the facts, and the law on implying terms does contain just enough flexibility as to allow the court to legitimately reach the decision that it has. Nine times out of ten, however, a case like this could well have had the opposite outcome.

The seller in this case was a businessman who was legally advised and entered into a complex, negotiated, written commercial contract. He very narrowly avoided losing out on a lucrative overage arrangement because of loose drafting at the outset of an apparently mutually-beneficial arrangement when, no doubt, relationships were good and trust between the parties ran high.

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.

When entering into overage arrangements, parties and their lawyers should consider very carefully what exactly will trigger overage payments and whether there is any scope at all for either party avoiding its obligations. Ideally, provisions should include clear and specific timescales within which conditions should be met; obligations should arise; and payments should be made.  Wherever there is any scope for uncertainty, formulas for ascertaining values; mechanisms for enforcing obligations and resolving disputes; and longstop dates for payment should be included expressly in the contract.

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[1] [2017] EWHC 1994 (Ch)
[2] See our earlier briefings on the subject of implying terms: (1) on the leading case of M&S v BNP Paribas: https://www.walkermorris.co.uk/publications/break-clauses-apportionment-and-implying-contractual-terms-supreme-court-puts-an-end-to-the-confusion/; and (2) a recent key contract case update: https://www.walkermorris.co.uk/publications/disputes-matter-spring-2017/contract-interpretation-key-case-update/;

 

 

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