Indexation, indexation, inflation

United Kingdom

Inflation is high and indexation adds significant cost to planning obligations. So is it time to take a different approach to indexation clauses in section 106 agreements?

Most section 106 agreements contain an indexation clause. These clauses may increase section 106 financial contributions to reflect the rate of inflation. We are now experiencing the highest levels of inflation for decades. This is focusing attention on indexation.

Planning obligations requiring the payment of money are calculated at the date of the local authority's planning committee (or the date of the planning officer's delegated report), but the payments may not fall due for several years.

Until recently, it was unusual for indexation clauses to be a focus of the negotiations between developers and local planning authorities. There is now a renewed focus on choosing the right indexation mechanism for the project when the section 106 agreement is negotiated.

For existing agreements these principles would also apply if deeds of variation are negotiated subsequently, and the developer seeks to alter the original indexation provisions.

Why is it important to negotiate on indexation?

Indexation has potential to add significant additional costs to a development which may not have been included in the original financial model.

A typical indexation clause requires that any sums due should be increased in accordance with the following formula:

A = B x C/D where:

(a)      A is the sum actually payable;

(b)      B is the original sum mentioned in the section 106 agreement;

(c)      C is the RPI for the month prior to the date the sum falls due; and

(d)      D is the RPI for the month prior to the date of the section 106 agreement.

Let's assume the following:

  • the section 106 agreement contains one obligation to pay £5 million to the local planning authority;

  • this sum falls due to be paid in its entirety in July 2022; and

  • the section 106 agreement is dated 15 July 2021.

This would make C the RPI figure for June 2022, which is 340. D would be the RPI figure for June 2021, which is 304. Therefore, C/D would be 1.12.

The total amount due after indexation would be £5.6 million. This constitutes an additional £600,000 payment. In some cases, a figure this large could severely impact on profitability and therefore deliverability.

Choice of index

The most commonly used indices are the Retail Price Index (RPI), the Consumer Price Index (CPI) and the Building Cost Information Service (BCIS) Index.

When indexation is calculated, reference is made to the change in the chosen index over time. Parties to a section 106 agreement should check the impact of the index being used.

The popularity of different indices has changed through time. For example, the use of RPI has received some criticism from economists in recent years. It is worth noting though that once the section 106 agreement is agreed, the choice of index will be fixed. The indexation clause might allow for the replacement of the index if it is phased out (e.g. if the relevant index stops being published).

When are payments indexed from?

The indexation clause will specify the point at which indexation begins. The clause will identify two points in time at which reference should be made to the index. The ratio of increase in the index from date X to date Y will then be applied to the financial contribution.

Date Y is normally the date on which the payment is due to be made to the local planning authority under the section 106 agreement.

Date X may vary. We often see the following options used:

  • The date of the relevant planning policy;

  • The date of the planning committee meeting in which the local planning authority resolved to approve the planning application;

  • The date of the section 106 agreement; or

  • The date the planning permission is issued.

The developer is usually keen to make date X as recent as possible (under the expectation that indices only increase through time). However, from the local planning authority's perspective, the contributions may have been set at much earlier date when a policy was made, so it could make sense to have the indexation applied from as close to that date as possible.

Which payments are indexed?

It does not follow that each and every financial contribution which falls due under a section 106 agreement should be indexed.

There are often sound arguments for carving out some financial contributions from indexation. This might apply to contributions in respect of which the actual amount to be paid is uncertain when the section 106 agreement is negotiated. If the potential for additional future costs and inflation has been taken into account when the initial figure was set, this might form the basis of an argument that indexation should not be applied.