In the current climate it is becoming increasingly common in sales and purchases of land for development to incorporate overage provisions, also known as “uplift” or “clawback” clauses – the purchaser pays an initial purchase price, and then potentially further sums are payable to the seller in the event that the property is transferred on for a profit. This is of benefit to a purchaser who is seeking to protect their cash flow position, and avoids the element of risk should the site not make the profit originally projected. The seller benefits from achieving a sale which may otherwise have been more difficult, and future profit shares are also beneficial to a seller from a cash flow perspective. It should be a win-win situation, depending on how the contract is negotiated.
However, a recent decision by the Supreme Court in the case of Aberdeen City Council v Stewart Milne Group Limited [2011] UKSC 56 has implied terms into a contract to reflect what it decided to be the intention of the parties, rather than enforce the actual wording contained in the contract, and reveals several important points which developers and their advisors must consider when striking deals where part of the purchase price is based on overage.
The dispute
Aberdeen City Council concluded missives in November 2001 (which were amended until August 2004) for the sale of a business park development site at Westhill, Aberdeen to Stewart Milne Group Limited (SMG). The price was £365,000, but the missives provided for a further payment to the Council in the event that the site was subsequently sold on by SMG. The further payment was to be calculated by taking a percentage of the gross sale proceeds of such a sale and subtracting the allowable development costs.
In 2006, SMG disposed of the site to a company within their own corporate group at considerable under-value. The price paid was less than the allowable development costs and as such SMG contended there was no uplift payable.
The Council refused to accept SMG’s contention that no uplift was payable, and argued that the uplift should be calculated with reference to the open market value of the subjects, rather than the actual price received when SMG sold the site on. The market value of the subjects was in the region of £5.5 million, more than 10 times the actual sum paid to SMG. After failing to win their argument in the Court of Session, SMG appealed to the Supreme Court, arguing that the actual wording of the contract dictated that the uplift should be payable with reference to the actual price received, rather than the market value of the site.
The decision
Two opinions were delivered with which the remaining judges agreed. Both found in favour of the Council, although their respective reasoning differed slightly. SMG were ordered to pay the Council in the region of £1.7million, having themselves received less than £500,000 for the subjects.
In the first of the Court's opinions, Lord Hope undertook a brief analysis of the actual terms of the missives before concluding that, clearly, a completely literal construction of the contract would lead one to side with SMG. The reference in the clause providing for payment of the uplift in the event of a sale by the appellants, to “gross sale proceeds”, on its own, would seem to anticipate a connection with the actual price received, rather than the market value, in the calculation of the uplift. Despite that, the Court chose not to give the clause its literal interpretation, for two main reasons.
Interpreting the contract as a whole
Firstly, in addition to a sale by the appellants, there were two other situations in which the uplift was payable. These were, in general terms, if SMG leased out the site for a term of more than 25 years, or if SMG wished to buy out the Council’s share in the land with the benefit of all necessary consents and agreements for its development. Importantly, in both of these circumstances, the uplift was to be calculated with reference to the market value of the site. Looking at the contract as a whole, on this basis there would be no difficulty in implying a term to the effect that the open market value should also be the criteria for calculating the uplift where SMG sold the site, whether at an under value, or otherwise.
Infelicities of drafting
During Lord Hope’s analysis of the missives, he highlighted several examples of “untidy drafting”, and because of these “infelicities”, he was inclined to put the issue between the parties down to oversight rather than deliberate intention of the parties. In other words, the credibility of the entire contract was undermined by the numerous examples of bad legal drafting. An argument that SMG would never have intended to pay out the uplift before realising a profit from the development, was rejected, since they would not have received a capital sum on the grant of a lease either, but the missives provided for SMG to pay the uplift in those circumstances.
Accordingly the Court found that the intention of the parties when drafting the contract was that the open market value should be used in calculating the uplift, notwithstanding the actual wording of the contract.
In the second opinion, Lord Clarke preferred to look at the dispute in more concrete terms, noting that there was no ambiguity in the interpretation of the contract, and that the only realistic interpretation was that the actual sale proceeds were to be used to calculate the uplift, and not the market value of the site. However, it could be assumed that the intention of the parties was to use market value, and a term should be implied to provide that the market value should be used as the reference for calculation of the uplift.
Practical considerations
In the light of this decision, the conclusion could be drawn that the court will step in to imply contract terms rather than allow a party “to suffer the results of its commercial fecklessness”, but for sellers and purchasers of developments sites, there are several lessons we can learn.
Firstly, it is common to see sales of completed dwellinghouses, electricity substations, gas governors, and the like, as well as the dedication or transfer of roads or footpaths and amenity areas being excluded from the obligation to pay an uplift - essentially, anything ancillary to the purchaser’s development which will not usually generate an unforeseen profit. Transfers to group companies should also be specifically excluded from the uplift obligation, with provisions for the uplift provision and any associated security to be assigned if a group company transfer takes place.
Secondly, the courts have shown a willingness to look at a contract as a whole in order to determine the underlying intention of the parties when it comes to the construction of a particular term. Thus, when including a provision that is different from other provisions in the contract, care should be taken to make clear that the provision reflects the true intention of the parties. In the present case this could have been achieved through the inclusion of such wording in the original missives as "for the avoidance of doubt, the actual sales proceeds received by the Purchasers and not the market value of the Subjects of sale will be used for the purposes of determining the uplift payable by the Purchasers”. The importance of contractual certainty when it comes to high value transactions cannot be overstated, and extra steps should be taken where a particular clause stands in the face of the more general terms of the contract.
Lastly, a key message to be taken from the decision, and in particular Lord Hope's judgement, is that sloppy or careless drafting can lead to an entire contract being undermined when its individual terms come under scrutiny. While it goes without saying that contracts should be drafted with due care and diligence, it may be dangerous to focus solely on certain "important" clauses. The contract should be carefully considered in its entirety, and advice should be taken from your solicitor where any clause, no matter how unimportant it may seem, seems unclear.
To view the decision in Aberdeen City Council v Stewart Milne Group Limited click here.