Option agreements, overage and implied terms.

Is a developer obliged to sell in order to trigger an overage payment?

Background

In an option agreement with overage provisions, where the seller is entitled to overage once new dwellings are sold, is there an obligation on the buyer to sell the dwellings once built, thus triggering the entitlement to overage?  In a nutshell, this was the question that arose in the recent decision of Sparks v Biden [2017] EWHC 1994 (CH).

The option agreement in that case was not a particularly lengthy document, albeit it was one drawn up by solicitors for both parties. Briefly, it contained provisions for the grant of an option to the buyer to buy land. If the option was exercised, the purchase price under the resulting sale would be £600,000 plus overage. The buyer was required to apply for relevant planning permission within three years of the agreement and to use all reasonable endeavours to obtain it. The buyer’s option over the land could be exercised in the same three year period. If the relevant planning permission was issued within that period, the buyer had one month to exercise the option. If the option was exercised and the sale completed, the buyer was required to proceed as soon as practicable to construct the development in accordance with the permission obtained and any other necessary consents.

The seller was entitled to overage once any new dwellings were sold (being a freehold or long leasehold sale), based on 33 1/3% of the sale price of each new dwelling but subject to two conditions. Firstly, that overage only arose with regard to sale proceeds in excess of the purchase price of £600,000, so that the buyer was not obliged to pay overage in relation to the first £1,800,000 received from relevant sales. Secondly, irrespective of the first condition, the seller was in any event to receive a minimum of £700,000 by way of overage in addition to the purchase price of £600,000. The option agreement was subsequently varied in relation to some of the timings and figures involved, but the broad structure of the agreement remained in place.

What happened, in fact, was that the buyer obtained planning permission for the development of eight houses and went on to construct them. However, rather than selling them, all but one were let on assured shorthold tenancies, with the buyer occupying one himself.

The buyer’s argument was that there was no express term in the option agreement requiring him to sell and so he had an unfettered discretion as to whether to sell or not. Thus the payment of overage could be delayed indefinitely. By contrast, the seller argued that such an interpretation fundamentally undermined the option agreement and that a term should be implied requiring the seller to sell each newly constructed house either as soon as reasonably practicable or within a reasonable period of time.

When will the court imply terms into a contract?

Usually, if a contract does not express what is to happen when an event occurs, then nothing is to happen, otherwise the parties would have spelt it out. However, terms may be implied where the following conditions are satisfied:

1. It must be reasonable and equitable;
2. It must be necessary to give business efficacy to the contract, so that no contract will be implied if the contract is effective without it (or, put another way, a term can only be implied if, without that term, the contract would lack practical or commercial coherence);
3. It must be so obvious that “it goes without saying”;
4. It must be capable of clear expression;
5. It must not contradict any express terms of the contract.

Expanding on the above, 2 and 3 are alternatives in that only one need be satisfied.

Here, the seller’s argument was that the contract itself was relatively compressed and so it was not surprising that an obligation to sell within a specific time period was not mentioned. However, the fact that the seller was to receive overage based on a percentage of the sale price made the obligation to sell obvious, as it would otherwise lack any commercial coherence. The buyer responded by saying that the background to the agreement left no room for implication of a term and that it was anyway not clear what that implied term should be.

In terms of the procedural background to be taken into account, the judge accepted that reputable solicitors had drawn up the agreement which was not a “standard document” which ordinarily would have pointed against the implication of any term.

However, the judge was not prepared to consider in any depth the buyer’s additional argument that the agreement was negotiated back and forth at length between the parties, reflecting negotiation and renegotiation of essential terms. The detail of this evidence was held to be inadmissible, on the basis of the “exclusionary” rule, namely that evidence about pre-contractual negotiations are inadmissible when construing a contract. This rule meant that the judge was not able to consider the detail of those negotiations, albeit he was able to take into account the more general point that there had been negotiations over some time.

As for the substantive background, the judge held it to be relevant that the parties were both businessmen and that the buyer was a developer. It was also relevant that the seller was not a developer but was effectively seeking to profit personally from the development in order to fund his retirement. Taken together, this pointed, in the judge’s view, to an implication of a term requiring the buyer to sell developed properties so that overage would become payable.

As for what terms should be implied, two propositions had been put forward by the seller, firstly, a sale of each new house to be effected, “as soon as reasonably practicable,” and, secondly, that such sale had to be effected “within a reasonable period of time.” The judge held the second option to be applicable, thus allowing the buyer, when selling the new houses, to take account of whether it was reasonable, in terms of price, to sell at a particular time. In addition, the general principle is that, where a contract does not expressly, or by necessary implication, fix any time for the performance of a contractual obligation, the law usually implies that it shall be performed within a reasonable period. The judge rejected the buyer’s argument that a term should not be implied on the basis that it could not be formulated with reasonable precision.

In terms of remedy, the judge was content to make an order for specific performance, so that the buyer was obliged to sell the new houses, with the detail as to the reasonable period of time within which those sales had to take place to be left for further evidence and court orders, in due course.