What is "overage"? What are the constituent elements of an overage clause? How long will it last? What will trigger the payment? How will the payment be secured? What are the drafting issues?
In this very detailed article Peta Dollar, the editor of the Property Transactions section of the site, answers these questions and more.
What is "overage"?
When land is sold, the vendor will normally do his best to sell at the best possible price - indeed, if the vendor is a public sector authority or a charity, he may be obliged to sell at the best possible price. Sometimes, however, the best possible price may only be available at some time in the future, or not at all. The most common example of this is where planning permission may be granted for a more valuable use of the land, but it is by no means certain that the permission will be forthcoming and, in any event, this is unlikely to happen for some time. Similarly, if land is sold for a particular purpose, such as for the development of 50 houses, and the developer in fact manages to build 60, then the land will obviously be more valuable with 60 houses on it rather than the original 50.
"Overage" is the term normally used, in the context of a property transaction, to mean a sum which the vendor may be entitled to receive after completion if a specified condition is satisfied; the condition may be:
A more complex type of overage can be linked to the profit ultimately made by the purchaser/developer from the development of the land. In this case, it will be necessary to calculate the total proceeds of sale from the development and to deduct from them all relevant costs incurred by the developer, including land purchase, fees, development costs, a fair commercial profit for the developer, etc. What remains can then be divided between the original landowner and the developer in specified shares.You may sometimes hear reference being made to "positive overage" or "negative overage". Positive overage means a requirement, imposed on the buyer/payer, to make a payment upon the happening of a future event. Where, however, a restrictive covenant has been imposed on the land purchased by the buyer/payer, or a ransom strip has been created to restrict the use of that land, the sum payable by the buyer/payer in order to get that covenant released (or to acquire the ransom strip) may be referred to as "negative overage".
- The grant of a new planning permission; or
- The grant of planning permission for a new (perhaps more valuable) use of the land; or
- The construction of more than a specified number of houses, or a larger than specified commercial development on the land; or
- The on-sale of the land in its present state, where the vendor fears that the purchaser may take advantage of a rapidly rising market to make a quick profit from the land. This will be particularly useful in the case of a vendor who is anxious not to be embarrassed by being seen to have sold at an undervalue, such as a local authority or charity.
What are the constituent elements of an overage clause?
There are five main constituent elements of an overage clause, namely:
- What will trigger the payment?
- How much will the payment be, and how will it be calculated?
- Will making a payment release the obligation?
- How will the payment be secured?
The duration of an overage clause normally depends on the nature of the event which will trigger the payment, and the likely timescale for this to occur. If the land is being sold to a developer who will immediately apply for planning permission, then a relatively short period of time may be negotiated - perhaps 5 years at most. But if the land that is being sold is within the Green Belt and may not be available for development for perhaps 20 years, a much longer timescale is likely to be agreed. Ultimately, the duration of the obligation upon the purchaser to pay overage is a matter of negotiation between the parties, and what is agreed will ultimately depend on the strength of their respective bargaining positions. "There used to be a possible issue regarding securing overage payments for more than 80 years because of the rule against perpetuities, but this has been changed by the Perpetuities and Accumulations Act 2009 for documents that “take effect” on or after 6 April 2010." (For a general explanation of Perpetuities see Perpetuities page)
What will trigger the payment?
Generally the starting point will be the grant of planning permission in respect of the relevant land - but there are many additional details to consider, including:
There are all sorts of traps for the unwary - for example, where the trigger for payment is linked to sale of the last house in a development to be sold, it has been known for a house builder never to sell the last house, just to avoid the payment! (But see the case of Renewal Leeds Ltd v Lowry Properties Ltd  EWHC 2902 (Ch), where the Court rescued a seller in this predicament by implying an obligation to build and sell all the houses). If you are acting for the seller/payee, make sure that you tie the trigger to some event that cannot easily be avoided.
- Should the trigger for payment of overage be outline or detailed planning permission? Or should a resolution to grant planning permission be sufficient? Or even a change in the relevant Local Plan? Clearly the starting point for the seller/payee will be a change in the relevant Local Plan, the starting point for the buyer/payer will be the grant of detailed planning permission, if not indeed completion of the development pursuant to that detailed planning permission! But concerned though the seller/payee may be to receive his money at the earliest possible time, he must bear in mind the fact that it may be difficult to value the land when it has merely outline planning permission or even just the benefit of zoning in the relevant Local Plan, and he may receive more money if he waits for a detailed planning permission to be granted.
- What happens if the planning permission is never implemented? Don't forget that anybody can apply for planning permission in relation to land, even if he owns no interest in that land. The seller/payee, or his agent, could successfully apply for a "better" planning permission on the relevant land, but the buyer/payer may have no intention of implementing such a planning permission. Should he nonetheless have to pay overage on the basis of that improved planning permission, for which he did not apply? (Micro Design Group Ltd v BDW Trading Ltd  EWCA Civ 448 see below).
- What if the land is sold to a third party before planning permission is granted? The seller/payee may want to receive his overage payment then, but the land may not yet have increased in value? Will the seller/payee want the third party to pay him overage when the planning permission is finally granted? If so, he will want to have a contractual link between himself and the third party, and securing the overage will be an issue.
- Will the buyer/payer have the money to pay the overage unless he has sold the land with the benefit of the planning permission? There is no point in the seller/payee requiring his overage to be paid at the earliest possible opportunity if the buyer/payer simply will not have the money to pay until the land has been developed and sold.
In London and Ilford Ltd v Sovereign Property Holdings Ltd  EWCA Civ 1618 a developer was granted approval to build 60 flats but the flats could not be built because they would contravene building regulations. Despite this, the developer was required to pay overage payments to the seller of the land, because the trigger for payment of overage was the grant of approval to build.
The Court of Appeal pointed out that regime for planning and development consent and the regime surrounding building regulations were entirely separate in their purpose, legislation and enforcement. The first trigger event was clear and expressly concerned with change of use, which was a planning and development issue. There was no mention in the overage agreement of compliance with building regulations or any other requirement that might need to be satisfied before the Residential Units could be built. If it had been intended that the first trigger event should require any such compliance, the parties would have made express provision to that effect. Both were experienced developers and had been professionally advised.
By defining the first trigger event by reference to prior approval for the defined proposal, the parties had attached significant value to the receipt of that approval. An ordinary reading of the agreements did not support the buyer's argument that such prior approval had no utility unless it related to Residential Units that were capable of being built.
How much will the payment be, and how will it be calculated?
The important thing here is to keep it as simple as possible, for the benefit of both parties. The more complex the formula for calculating the payment, the more likely that something will be left out, such as a bracket, and the formula may not then fully reflect the parties' intentions. Often it will be impossible to avoid an open market valuation; in that case, if land is being valued with and without planning permission, or with one permission and then with a different (improved) permission, it is important (at least from the point of view of the buyer/payer) that the valuation date is the same in each case, otherwise like is not being compared with like. It is unlikely that the parties really intend for the buyer/payer to pay more money to the seller/payee just because property values have increased due to inflation or a sharp rise in the property market. Note also that where land is being valued without planning permission, the hope or expectation that planning permission may be granted should also be ignored: see Walton Homes Ltd v Staffordshire CC  EWHC 2554 (Ch).
Incidentally, if land is being valued with and without the benefit of a particular planning permission, it is sensible to choose a valuation date that is as close as possible to the date on which the valuation is actually being carried out, as there may be problems in finding historic values for the land. So where the comparison is between land without the benefit of planning permission and the same land without the benefit of the permission, it is best to carry out both the valuations as at the date of the planning permission. There is no problem in principle with carrying out both valuations as at an earlier date, but as I have said, there may be a practical problem in ascertaining the values at that date.
Other alternative methods for calculating overage, which will not require a third party valuation to be carried out include providing for a specified payment to be made in respect of each unit built (or permitted pursuant to the planning permission) or each unit built or permitted in excess of a specified number of units, or each square metre of development built or permitted. If the overage payment is based on measurement, it is a good idea to have surveyor input into how the development is measured, i.e. gross or net, internal or external, etc. If the payment is simply based on a specified percentage of sale proceeds paid to the buyer/payer what about the buyer/payer's expenses of the sale? The seller/payee's solicitor should ensure that the buyer cannot simply avoid the payment by transferring to a related purchaser for no more than the original sale price and then allowing that related purchaser to sell on at a profit.
Unless the overage provision is very simple, e.g. a fixed sum is payable within a fixed period of grant of any planning consent, it is often a good idea to separate out each part of the obligation and in particular, to provide a mathematical formula for any calculation. If it is particularly complex - and sometimes, the overage provision may effectively be a sharing of profits clause - then it is helpful to set out a worked example; this tends to concentrate the mind of the parties and any surveyors involved and, if the worked example produces a ridiculous result, then it becomes apparent that there is something the matter with the overage calculation formula. Without the worked example, however, it may be far more difficult to see that an error has been made in the formula
Will making a payment release the obligation?
Sometimes the overage payment will be a one off payment, arising from a single development - so payment of that sum will release the obligation. At other times, the overage payment may be tied to any planning consent that is granted within a set period. Make sure that the drafting is clear on this point.
How will the payment be secured?
There are numerous ways of securing overage payments, but none of them is entirely satisfactory. They include the following:
The first example is not really a way of securing overage payments at all - it is simply to rely on the contractual arrangement, the buyer's personal liability to perform the obligation and make the payments, and not seek any form of security. This example is highly unlikely to be acceptable to a seller/payee unless the buyer/payer is particularly strong, both financially and in terms of reputation. In the case of a national institution, or a Government Department, or even a major PLC, where the possible overage payments are relatively small, a seller might possibly wish to consider this option. Note that in the case of Akasuc Enterprise Ltd v Farmar Shirreff  EWHC 1275 (Ch), a solicitor was held negligent for not having included any form of mechanism to secure the overage payment, and it was stated that an unsecured promise to pay overage was not sufficient. If the seller decides to agree to the absence of any form of security for the overage payment, his solicitor should clearly explain the consequences of this in writing in order to avoid a possible future claim for negligence.
Contractual obligation plus guarantee
The second example is really a variant of the first example a contractual arrangement secured by a guarantee, whereby the guarantor will make good the loss if the buyer does not perform. The guarantor may be the parent company of the buyer - in which case, the vendor is unlikely to be happy except where the guarantor is particularly substantial - or, rather better for the vendor, the guarantor may be a bank or other financial institution. This example is ideal for the vendor but not so ideal for the buyer, who must pay a fee to the bank for the guarantee. If the liability is to continue for a long period of time, an annual fee must be paid, making it a very expensive option for the buyer. Also, the bank will not accept an open-ended or uncertain liability so the amount of the overage must be ascertained, so that the guarantee can be capped at that amount, and this may not be appropriate in some cases.
Charge over land
The next example is a very obvious one indeed - a charge over the land being sold, to secure payment of the overage. This is fine for the vendor but may be problematic for the buyer if he is borrowing the purchase price for the land and must mortgage the land in order to secure his borrowing. In that case, the buyer may be unable to offer any kind of charge to the seller or he may be able to offer a second charge, which is highly unsatisfactory for the seller if things go wrong (and in any event will require a deed of priorities to be entered into between the seller and the first chargee). Note also that if the buyer goes into liquidation and the liquidator disclaims the overage payment obligations as being onerous, the seller's entitlement under the charge will be limited to liabilities accrued at the date of the disclaimer - see Hughes v Groveholt Limited  EWCA Civ 897, where the right to the overage payments was still dependent on a contingent event that had not yet occurred, so no payments could be claimed by the seller.
Lease over land with right of re-entry
Another example, this one only rarely appropriate, is a lease over the land being sold in favour of the vendor, containing a right of re-entry in case of default in relation to the overage payments. Again, this will not be appropriate where the buyer has charged the land to a third party. In principle, it is possible to reserve a right of re-entry on the sale of the freehold, so that ownership of the land reverts to the seller if overage is due but is not paid, although it is seldom used in practice and there is some doubt as to whether it would be enforceable (see Reverse Option, below). Note that such a right must be protected by notice on the register of the land, and the obligation must comply with the rule against perpetuities, i.e. the right cannot be exercised more than 21 years from the date on which it was granted.
Positive covenant to pay
The next example is a more common one - namely a positive covenant by the buyer to the seller to make the payments. The problem with this example is that the burden of the covenant, being a positive one, will not generally run with the land so as to burden a successor in title of the buyer unless it is coupled with a restriction, registered at the Land Registry when the sale of the land is registered, preventing the registration of any dealing with the land unless a direct covenant to pay the overage is given by the purchaser. The difficulty with this example is the need for the seller to get involved in each further sale of the land, in order to confirm that the direct covenant has been duly paid and that the registration can proceed. Where the land is being developed as a large estate, for example, the seller will need to be involved in quite a lot of administration in order to protect his position - although clearly he would not expect a direct covenant from the purchaser of an individual residential unit.
The next example is rarely used, namely a reverse option, or call option, granted in favour of the seller, exercisable if overage is due but not paid. This must be protected by a notice on the register of the land.
There is also the risk that such a provision will be held to be a penalty clause and hence unenforceable in the courts. The rule against penalties is not restricted to promises to pay money, and may apply also to a term in a contract that requires a party in breach of contract to transfer non-monetary property to the non-defaulting party. In the case of Jobson v. Johnson  1 WLR 1026, the obligation to re-transfer property if there was a default in payment related to shares rather than land, but the Court of Appeal held that the clause was a penalty clause. Indeed, Dillon LJ stated "a transaction must be just as objectionable and unconscionable in the eyes of equity if it requires a transfer of property by way of penalty on a default in paying money as if it requires a payment of an extra, or excessive, sum of money."
More recently, the case of Warnborough Ltd v Garmite Ltd  EWHC 10 (Ch) looked at an arrangement whereby a separate option was granted, entitling the vendor to re-acquire the land at the original sale price if there was a default in making payments, and considered whether the option was a penalty or forfeiture provision in respect of which the court could grant relief. The court held that the option was not a penalty because if it were to be exercised, the parties would be restored to their original positions before the sale and purchase took place. The option was, however, held to be a forfeiture provision but the court stated that it would be impossible to grant relief from forfeiture.
This is a more common example, namely the retention of a "ransom" strip of land by the seller, which prevents the buyer from developing the relevant land until the overage payment is made. The problem with this example is that it may be possible for the buyer to obtain an alternative means of access, and effectively bypass the ransom strip. The seller must also ensure that the buyer does not obtain title to the ransom strip by adverse possession or obtain rights across the ransom strip by prescription.
It would be possible to impose a rentcharge over the land, in which case an equitable right of re-entry under the Rentcharges Act 1977 for breach of condition (i.e. the obligation to pay the overage) could be noted on the register. However, registration of a rentcharge would affect the buyer's ability to mortgage the land.
More seriously, the Rentcharges Act 1977 only permits the creation of a new rentcharge where it is an “estate rentcharge” (or in other circumstances not relevant in the context of overage). An estate rentcharge may be created for the purpose of securing the payment of expenses incurred in providing services (i.e. a type of service charge arrangement that binds freeholders) or for the purpose of making covenants enforceable. In the latter case, the rentcharge must be of a nominal amount only. This would appear to preclude the use of a rentcharge to secure the payment of overage.
It is common for a local authority not to sell land outright, but to grant a building lease that contains the overage provisions. As the freehold interest in the land will not be transferred to the developer until he has completed his development of the site, any improvement in the planning permission will then be known and can be paid before the freehold is transferred. Alternatively, the authority can convey the freehold of each part of the completed development direct to the end-user, upon payment by the developer of the relevant overage. Any non-performance by the developer of his obligations under the lease could result in forfeiture, subject of course to the court's power to grant relief from forfeiture.
The final example is probably the one that has most commonly used one, namely a restrictive covenant, preventing the development of the land in accordance with any future planning permission, e.g. by restricting the development of the land except by the construction of the originally agreed number of units, or the originally permitted development.
However, recent case law has held that a covenant which is imposed purely to lead to a payment of money is not one which should be regarded as being capable of benefiting other land and should not be enforceable as a restrictive covenant against successors in title of the original covenantor (Cosmichome Limited v Southampton City Council (2013).
That is not the end of the problems: The Upper Tribunal (Lands Chamber) has wide powers to modify or discharge restrictive covenants, particularly under Section 84(1)(aa) of the Law of Property Act 1925 (note that a covenant does not need to be obsolete for the section to be invoked, it merely needs to be preventing a reasonable use of the land, and on the face of it, any use for which planning permission has been granted is a reasonable use). See further Modification and discharge of restrictive covenants.
And, as previously stated, restrictive covenants are generally expected to benefit the amenity of the seller's retained land - not provide him with a windfall sum of money, and any compensation paid to the seller if the covenant is breached (or varied or discharged under Section 84 of the Law of Property Act 1925) is unlikely to be equal to the amount of the intended overage payment, since it will be calculated by reference to the diminution in the value of the seller's retained land. In the case of Re Withinlee (11 February 2003), the Lands Tribunal discharged a restrictive covenant in favour of a "ransom strip" under Section 84(1)(aa), where a payment was required to be made if the subject land was to be developed, holding that "any practical benefits of substantial value or advantage" excluded any financial benefit conferred by the covenant. The strip had little development potential itself, so that development of the subject land would not detrimentally affect its value.
The restrictive covenant will therefore only work if the seller retains nearby land that will be adversely affected by the implementation of the new planning permission. It may be that the seller simply does not have any other relevant land - note that, for example, the subsoil of a highway is not capable of benefiting from a restrictive covenant - or that a mere strip of land is retained, in which case the diminution in value of that strip of land by virtue of the new development will always be significantly less than the overage payments which may be due. Hence the overage payments may not be enforceable, as the Lands Tribunal may simply vary the covenant and award a nominal sum to reflect the actual diminution in value of the seller's retained land (as happened in the case of Re Withinlee, see above). There is a particular problem where the seller wishes to protect himself against an improved planning permission being granted to the buyer - the diminution in value of the seller's retained land where 70 houses have been built next door, rather than 50 houses, is very small but the overage provision might have been intended to give the seller, say, one third of the price of each such additional house.
Avoiding the need for security
The need for security, with all its attendant difficulties, can be avoided altogether by the vendor granting to the purchaser an option to acquire the property, or the parties entering into a conditional contract for the sale of the property. Provided that completion does not occur until after planning permission has been granted, the purchase price can be calculated on the basis of market value using the actual consent that has been granted. Note, however, that such an arrangement would not assist the vendor at all in a situation where a possibility exists that the planning permission may be improved following completion of the sale and purchase.
An example - drafting issues
Let us look at a typical example of an overage provision. Land is to be sold for residential development, on the basis of an existing planning permission. The parties have agreed that if extra dwellings are in fact built as part of the development, overage will be payable by the buyer to the seller (presumably because the value of the land will actually have been shown to have been higher than the original sale price).
Some questions that the draftsperson should consider, preferably before drafting the overage clause, include:
The difficulties of drafting a clear trigger for the payment of overage were particularly well illustrated in the case of Primaplus Ltd v Hall Aggregates Ltd  All ER (D) 2374. The purchaser had, in the conveyance to him, agreed to pay the vendor 50 per cent of any increase in market value attributable to the grant of planning permission for the development of the site. The conveyance specifically excepted from that obligation any permission to use the site "solely as a garden centre or as a sports and recreation centre (or partly as one or partly as another such use)".
- When will the payment be made? Presumably nobody will know if extra dwellings are built until they have been built i.e. payment cannot be made until after practical completion of the development. But will the buyer/developer have the money then or must the seller wait until all the dwellings have been sold (and what if the buyer/developer cunningly fails to built the last one or two dwellings?)? Note that if the seller wants his money early, and the buyer is in a position to pay the money early, there is no reason why the overage payment should not be calculated with reference to the dwellings for which any new permission is granted, and then recalculated when the development has actually been completed, with any additional sum due being paid at that stage.
- What does "extra dwellings" mean? Will the seller only get his money if an additional number of dwellings are actually built? What if the same number of dwellings, but larger ones, is built? There will be an increase in the value of the development, so the seller/payee should properly benefit, but whether or not he actually does benefit will depend on how the formula is drafted. What if permission is actually granted for a commercial development instead - will there be a basis on which overage is payable in that situation?
- If payment is actually tied to floor area the draftsperson will need to define floor area, with the help of a surveyor. For example, should there be any deduction from the gross internal area on account of internal walls or internal structures? (What happens if these walls are subsequently removed?) Will all dwellings be included, or should social or affordable housing units be ignored? If so, what is the definition of these units? (Don't forget that affordable housing units will include those units where the purchaser pays only a percentage (say 70%) of the full market value and effectively pays "rent" on the remainder of the unit, but also units which are simply rented out at a subsidised rent - there is no reason why the relevant percentage of the value of the former type of affordable housing units (i.e. 70%) should not be included within an overage calculation, but where the unit is simply leased at a below-market rent, it should probably be ignored for the purposes of calculating overage).
- Does the buyer need to provide the seller with as-built drawings so that the floor area can be calculated? If so, when will he prepare them?
- Should the buyer be obliged to notify the seller of the grant of planning permission or of completion of the development? How will the seller find out about this if the buyer forgets to tell him?
- Is the overage only tied to the original development? What if extra dwellings are built on, say, land which has been left open as landscaping, some years later? Will the seller expect to benefit?
- Does a car parking space form part of a unit, for the purpose of calculating area? See Bride Hall Estates Ltd v. St George North London Ltd  EWCA 141, where this issue meant a difference of some £300,000 in the potential overage payment.
- What if an existing building is converted into a number of smaller units, rather than the original building being demolished and new units built directly on the land? Should the seller/payee benefit from the conversion as well as from the new build units? If so, ensure that the drafting refers to conversion and not just to construction of new units.
The issue to be determined was whether a payment was triggered by the grant of planning permission for "a public golf driving range, fishing lake and sports hall", which included a golf shop. The Judge held that no payment was due because the "public driving range, fishing lake and sports hall" fell within the exception (i.e. it fell within the definition of "sports and recreation centre"). The fact that there was to be a golf shop did not take the use outside it because the golf shop was incidental and ancillary to the main use.
Primaplus illustrates why a vendor needs to think carefully about the scope of the land's uses that will not trigger the overage provisions. If the vendor in this case had wanted to share in the increase in value generated by the retail use, then a specific provision should have been included. In planning terms, an entirely different use may be ancillary to the principal use and does not need a separate planning permission. (See also Hildron Finance Limited v Sunley Holdings Limited  EWHC 1681 (Ch), below).
Some particular cases
Finally, I would like to look at a number of cases involving overage:
Chartbrook Limited v Persimmon Homes Limited
 UKHL 38
This is a case involving a horribly complicated formula. In dealing with the case the House of Lords gave useful guidance on the construction of contracts and on rectification.
This case concerned a dispute over the construction of an overage provision in a sale contract. Part of the price was defined as the “Additional Residential Payment”; and this was said to be slightly less than £900,000 by Persimmon (the Payer) but just over £4.6M by Chartbrook (the Payee).
The definition of Additional Residential Payment was “23.4% of the price achieved for each Residential Unit in excess of the Minimum Guaranteed Residential Unit Value less the Costs and Incentives”. A Residential Unit was defined as “each of the flats forming private residential accommodation for which Planning Permission is granted”. The Minimum Guaranteed Residential Unit Value was defined as “for each Residential Unit the Total Residential Land Value [defined as £76.34 per square foot multiplied by the Residential Net Internal Area (less certain sums in relation to planning gain and rights of light] divided by the number of Residential Units for which Planning Permission is granted”. The Costs and Incentives meant incentives paid by the developer to the purchasers of residential premises.
The payee argued that the definition of Additional Residential Payment was: 23.4% x (Unit Price – Minimum Guaranteed Residential Unit Value – Costs and Incentives), whilst the Payer argued that the definition was: (23.4% x Unit Price) – Minimum Guaranteed Residential Unit Value – Costs and Incentives. In other words, the difference between the parties was the positioning of the brackets in the mathematical equation, and this gave rise to a massive difference in the amounts claimed to be due by each party.
The Payee argued that they were entitled to a 23.4% share of the net proceeds of sale of each residential unit in excess of a minimum guaranteed amount; The Payer, on the other hand, said that the Payee would only receive an additional payment provided that 23.4% of the net sales price amounted to more than the Minimum Guaranteed Residential Unit Value.
Briggs J, at first instance, ascertained the meaning of Additional Residential Payment by reference to the ordinary meaning of the language used. On its face, he considered the ordinary meaning of the definition clearly pointed towards the Payee's construction rather than that of the Payer, and accordingly interpreted the definition in accordance with the Payee's submissions.
Having done that, the Judge had to consider the Payer's claim for rectification. After considering the evidence at length, he came to the conclusion that the Payer had not proved either of its alternative rectification cases with sufficient clarity, and accordingly dismissed the claim.
The Payer unsuccessfully appealed to the Court of Appeal, which dismissed the appeal by a majority of 2-1. However, their appeal to the House of Lords was successful, their Lordships being unanimous, with the leading judgment being given by Lord Hoffman (who was giving his last judgment in the House of Lords).
In order to interpret a contract, it is necessary to ascertain the meaning which a “reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean” (per Lord Hoffman, para 14). For a mistake to be corrected by construction it is necessary both for the mistake to be obvious and for the correction needed also to be obvious (East v Pantiles); Lord Hoffman accepted this statement, subject to Carnwath LJ’s two qualifications in KPMG LLP v Network Rail Infrastructure Limited (that ‘correction of mistakes by construction’ is not a separate branch of the law but part of the single task of interpreting the agreement in its context, and that the court may take into account background and contextwhen deciding whether there is a clear mistake).
These requirements had been satisfied in this case, as the formula contained a grammatical ambiguity that had to be resolved by considering the business purpose of the provision. Lord Hoffman held that the Payer's interpretation gave the formula a ‘rational meaning’, stating that “to interpret the definition of ARP in accordance with ordinary rules of syntax makes no commercial sense” (para 16).
Lord Hoffman dealt with two important issues in his judgment, namely (1) construction and (2) rectification.
The parties had argued over whether or not the court should take into account pre-contractual negotiations. Lord Hoffman accepted that, in principle, previous negotiations were relevant background on an issue of construction; the general rule is that there are no conceptual limits to what can properly be regarded as background.
However, construction required an objective approach. Statements made in the course of pre-contractual negotiations were likely to be "drenched in subjectivity". Lord Hoffman considered that, if the exclusionary rule (which excludes consideration of pre-contractual negotiations) were abandoned, there was likely to be greater uncertainty of outcome in disputes over contractual interpretation. Reviewing evidence of pre-contractual negotiations would add to the cost and duration of resolving such disputes.
To disapply the exclusionary rule would have required the House of Lords to depart from a long and consistent line of authority. The House of Lords had the power to depart from an established rule under Practice Statement (Judicial Precedent)  1 WLR 1234, but this power was intended to apply where previous decisions of the House of Lords were impeding the proper development of the law or had led to results which were unjust or contrary to public policy. Lord Hoffman concluded that no case had been established for departing from the exclusionary rule.
Further, no exception to the exclusionary rule applied in this particular case. The exclusionary rule does not cause injustice because of two legitimate "safety devices"; in claims for rectification and estoppel by convention, evidence of pre-contractual negotiations is admissible.
The Payer had put forward an alternative argument, i.e. for rectification of the contract. In considering this, Lord Hoffman reviewed the relevant pre-contractual exchanges between the parties. He held that it was clear that a reasonable person reading the evidence in light of the background known to the parties, would have taken the parties to have intended that the overage should only be payable if, and only if, the project performed better than was anticipated at the time of the contract. This presumed intention supported the Payer's case and was evidenced by a particular letter. Lord Hoffman found no evidence of subsequent discussions which might have suggested an intention to depart from the terms of the letter.
If the proper construction of the overage provisions, as drafted, was in the Payee's favour, both parties had been mistaken in thinking that the definition reflected their prior consensus; and the Payer would have been entitled to rectification. However, the Payer's appeal on the grounds of construction had already been allowed.
Although the Payer was ultimately successful in the House of Lords, the moral of this case is (1) don’t draft over-complex overage provisions that you don’t fully understand; (2) if you do have to draft a complex overage provision, set out a proper mathematical formula for the provision, accompanied by a worked example; and (3) check and double-check that there is no typographical error in the mathematical formula before the document is finally executed and completed.
(It should be noted that since this case the Supreme Court in Arnold v Britton has said that:
... the reliance placed in some cases on commercial common sense and surrounding circumstances (eg in Chartbrook, paras 16-26) should not be invoked to undervalue the importance of the language of the provision which is to be construed" (para 17). So where the language is clear less weight will be attached to "commercial common sense" when interpreting contractual clauses).
Hildron Finance Limited v Sunley Holdings Limited
 EWHC 1681 (Ch)
When a large block of flats was sold in 1986, the seller incorporated detailed provisions for overage to be paid if the porter’s flat was no longer required to house a resident porter. These provisions required the flat to be sold on the open market and the price obtained, after deduction of the nominal figure attributed to the flat in 1986 and the buyer’s legal costs, to be split equally between seller and buyer.
Unfortunately, when the flat ceased to be used by a resident porter, the buyer was unable to sell it on the open market, as the tenants had exercised their collective enfranchisement rights under the 1993 Leasehold Reform, Housing and Urban Development Act, and the Act prohibited the flat from being sold. The freehold of the block was eventually transferred to the tenants at a price that attributed the sum of £200,000 to the former porter’s flat, the open market value of the flat being agreed to be £300,000.
However, Henderson J. held that the contractual machinery providing for the sale of the former porter’s flat on the open market was an essential part of the purpose of the overage agreement, and since it became impossible to carry out, the entire contract must fall. No overage was therefore payable to the seller, despite the fact that a substantial sum had effectively been paid to the buyer in respect of the former porter’s flat. A statutory provision that the parties had had no chance of predicting in 1986 frustrated the overage arrangements.
Sparks v Biden
 EWHC 1994 (Ch)
A buyer/developer had occupied one unit and let the others on short-term lettings, thus apparently avoiding an obligation to pay overage on the sale of the units. However, the court held that a term should be implied into the option agreement, obliging B to market and sell each newly constructed house within a reasonable time of the option having been exercised and the planning permission having been obtained.
Despite the fact that the proposed clause referred to a "reasonable time", the judge did not consider this term too imprecise to be implied. It was appropriate to allow the buyer some flexibility to take account of market conditions, and the fact that the clause required the weigh-ing of various factors did not automatically render it incapable of being implied.
The judge made a decree for specific performance, adjourning the exact wording of the order to be determined by the Master.
© Peta Dollar. I cannot assume legal responsibility for the accuracy of any particular statement, as the advice is on a non-specific basis. In the case of a specific problem, it is recommended that professional advice be sought.
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