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9 November 2017

The importance of a carefully drafted overage agreement

The recent High Court decision in Sparks v Biden [2017] highlights the importance of well thought out and precise drafting of overage agreements.

Facts

Mr Sparks owned a piece of land in Wimbledon which was ripe for residential development. Since he had no experience in development, he entered into an agreement with Mr Biden, who had 35 years experience in developing land. Mr Sparks granted Mr Biden an “option to purchase” the land, under which Mr Biden was obliged to use all reasonable endeavours to obtain planning permission and to construct new houses on the land in accordance with the planning permission.

If the “option to buy” was executed, Mr Biden had to “proceed as soon as practical” to construct the dwellings. The “option” was further coupled with an overage provision, which provided for:

  1. A percentage of the sale price over and above a minimum floor price per property sold; and
  2. A guaranteed minimum payment of £700,000 once “all the houses were sold, irrespective of the price”.

Eight houses were built on the land. Mr Biden proceeded to occupy one of the eight properties and he rented out the other properties on short term leases.

There was no obligation for Mr Biden to sell the houses and without sale of the last house, the minimum payment of £700,000 would not become due. Mr Biden pointed out that due to this omission, he could indefinitely forestall the overage payment by putting off the sale of the properties.

Mr Sparks argued that this manipulation undermined the entire agreement. He claimed it was an implied term of the agreement that once the land was developed, the properties should be sold within a “reasonable” amount of time.

The question for the court was therefore whether or not there was an implied term within the agreement obliging the buyer to sell, rather than lease, the newly constructed properties within a reasonable amount of time, which would trigger the overage payment.

Decision

In deciding whether to imply a term in the agreement, the court considered whether the clause was necessary (the business efficacy test) and if the clause was obviously implied to be part of the agreement (the officious bystander test).

The law on implied terms is summarised in B.P. Refinery (Westernport) Proprietary Limited v Shire of Hastings (Victoria) [1977]. If a term is to be implied, it must be:

  • Reasonable and equitable;
  • Necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it (“business efficacy test”);
  • So obvious that “it goes without saying” (“officious bystander test”);
  • Capable of clear expression; and
  • Not contradictory to any express terms of the contract.

That being said, a term will not be implied merely because it is fair, or the parties might have agreed it if it had been suggested and the court will not imply a term to cure a “bad deal”.

The judge decided that without the implied term, the agreement between Mr Spark and Mr Biden was lacking in practicality and was commercially illogical. Additionally, due to the nature and the wording of the “option to buy”, the judge considered that the sale of the properties was such an obvious part of the agreement that it went without saying.

The judge decreed specific performance to ensure the sale of each of the eight properties, taking “reasonable time” to mean that the buyer would be allowed time to consider market conditions and sell accordingly.

Practice point

Recent case law shows that it is still unusual for a court to imply a term into a contract. The seller was fortunate in this case to have an implied term incorporated into this agreement but with hindsight, it would have saved time, effort and money to have been more precise and thorough with the agreement originally.

This case goes to show that when drafting a complex commercial agreement, simple points are often overlooked and it is not enough to assume that something “speaks for itself”.

 

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