Promotion agreements: the advantages and disadvantages
Promotion agreements are fast becoming a popular choice both for landowners and developers and this article illustrates a brief summary of the advantages and disadvantages for both parties.
What is a promotion agreement?
Promotion agreements are a type of joint venture between landowners and a developer to maximise the value of the land. It is a way in which a developer, particularly those with short term plans, may choose to make profit without having to finance the acquisition or development of the land. For a landowner, the attraction is that the developer’s interests are aligned with the common objective of selling the property for the maximum value.
How it works:
- A premium is paid by the developer on completion of the promotion agreement;
- The developer is then obliged to do his best to secure planning consent for the site;
- Once consent is granted, the developer markets the property;
- Upon completion of sale, the net proceeds are shared between the developer and landowner – percentages will reflect the value of their contributions and the degree of risk taken by the developer.
Note that this will usually be less the developer’s costs of securing planning consent and the initial premium paid by the developer.
Advantages of a promotion agreement
The idea is that promotion agreements maximise the value of the property as it is usually in both parties’ interests that the land is sold and at the highest market value. Under an option agreement, by contrast, the developer is motivated to maximise its own profit by purchasing the land from the owner as cheaply as possible.
The developer will want to obtain the most valuable planning permission possible and, in theory at least, keep costs to a minimum, as they bear a percentage of them. The landowner can also be confident that the developer is less likely to agree to unreasonable terms with a local authority as it will affect his share of the proceeds of the sale.
Once planning permission has been achieved, with bidding from many interested developers encouraged, the sale price is market-tested and those involved can know that the best price was achieved. The value of the property will be determined by an actual sale as opposed to hypothetical market valuation (like in an option agreement).
Disadvantages of a promotion agreement
A significant disadvantage of promotion agreements concerns the timing of the sale which leaves a large scope for disagreement between the landowner and the developer. For example, during a period of recession, upon receipt of planning permission, whilst the developer may seek to market the property as soon as possible, the landowner may prefer to wait until the economic climate improves.
With the costs ordinarily being reimbursed to the promoter if planning permission is obtained, it is important to restrict the promoter from only incurring reasonable costs and consider capping them so that the landowner guarantees the amount being deducted from the price and reimbursed to the promoter. At the very least the costs should be restricted to third party invoiced costs to prevent the developer from charging you their internal management costs.
With the only security for the developer being the contract, careful consideration is needed on how to protect the significant costs the developer will incur in case the landowner has a change of heart.
With such significant out-lay in costs, inevitably the developer needs to consider how to protect its position in the event of insolvency or something going wrong. There are ways in which the developer can protect themselves, which may or may not be possible given the circumstances, including:
- Developer taking a first legal charge over the property
This may cause problems if the property is already subject to a mortgage, as the existing bank will have to agree to the arrangement being entered into. The legal charge would need to be carefully drafted to provide what will happen if they refuse to sell the land, how the parties will determine at what point a breach has occurred, and what the promoter would be entitled to receive in that event if the charge was enforced. If properly structured, it would give the developer the ability to exercise a power of sale.
- A residual option
This gives the developer the option to buy the land if the landowner refused to sell on the open market. Sale price takes into account planning cost and the share in the increased development value of the land (from the grant of planning permission).
Nevertheless, it is important to note that as yet, there have been no decisions in the courts on the effectiveness of these methods of securing the landowners obligations under promotion agreements.
There are also some significant tax traps to be aware of, not least that if the promoter charges VAT on its share of the proceeds (which is likely), the landowner must ensure they are in a position to claim this VAT back, as depending on values it could run into the millions of pounds. If this is not possible, then it is likely that a promotion agreement may not be the appropriate arrangement for the landowner, as this VAT issue does not arise with options.
Today promotion agreements are as popular as option agreements, whereas ten years ago they were almost unheard of. They have their place in the right circumstances, but you should ensure you are advised during the negotiation by an agent, lawyer and tax accountant who are all experienced in dealing with promotion agreements.