By Aaron Gadiel, Partner and Anthony Whealy, Partner

The NSW Government has given its official seal of approval to the push by local councils to ‘capture’ a share of development profits through planning agreements (often referred to as voluntary planning agreements or VPAs).

On 4 November 2016, the Planning Minister, Rob Stokes, released a draft ministerial direction, a draft planning circular and a draft practice note — all relating to the use of planning agreements.

In a nutshell, the Government has acknowledged that there is ‘growing concern’ that the development industry is being ‘held to ransom by some councils’.

However, there is no proposal to end ‘value capture deals’ in planning agreements.  Mr Stokes instead confirmed that local councils will be able to keep using planning agreements ‘to capture a reasonable share of the uplift in value from a rezoning, to help pay for community facilities and amenities’.

Instead the focus of the government’s announcement is that ‘value capture deals’ negotiated by councils with developers must be made ‘more transparent’.  Mr Stokes says this is necessary due to ‘growing concerns the process is pushing up new apartment prices’.

The detail of the government’s approach is set out in its draft practice note.

At its heart is explicit government approval for the idea that planning agreements can be used to obtain contributions from developers above what is required ‘to fairly and reasonably address the impacts of particular development on surrounding land’.

The draft practice note says that it is legitimate for planning agreements to be used to allow ‘the wider community to share in part of the development profit’.

The draft practice note sets out two key constraints on the extent to which planning agreements should be used to take a ‘share’ of development profits.

Firstly, there is an explicit recognition that developers have an entitlement to a ‘share of development profit’ — provided that the new development is ‘appropriately’ serviced by infrastructure.

The developer’s ‘share’ of the profit must not drop ‘below a point where the development is no longer feasible, the development may not proceed and benefits would not be realised’.

In order to take advantage of this new requirement, a developer may need to provide a development feasibility analysis to a local council on an ‘open-book’ basis.

Secondly, the draft practice note says that planning proposals, development applications or modification applications should not be blocked because a developer does not want to enter into a planning agreement related to land value increase.  Current local council policies that explicitly seek to secure a share of land value uplift are not supported by the draft practice note.

Some background and more detail are set out below.

Background

What are planning agreements?

Planning agreements are a special kind of agreement reached between developers and landowners (on one hand) and local councils and/or state government agencies (on the other).

Planning agreements are a hybrid legal document — a cross between a development consent and a commercial contract.  Unlike a conventional commercial contract, planning agreements must be considered, where relevant, when development applications are determined.  They are enforceable by third parties in the Land and Environment Court.  If registered on the land title, planning agreements bind future landowners (including mortgagees-in-possession) much like a development consent.

Unlike a development consent, there is no right of appeal to the Land and Environment Court because a local council:

• refuses to enter into a planning agreement; or

• is only willing to enter into an agreement in terms that are unacceptable to a developer.

The legislation has always anticipated that planning agreements must be ‘voluntary’. In that regard, they are defined in section 93F of the Environmental Planning and Assessment Act 1979 (the Act) as being ‘a voluntary agreement or other arrangement…’.

Similarly section 93I of the Act states that a planning agreement may only be imposed as a requirement via a condition of development consent ‘if it requires a planning agreement that is in the terms of an offer made by the developer…’ The Act also expressly states that a local council or planning panel cannot refuse to grant development consent because a developer has not offered a planning agreement

As distinct from development applications, planning proposals (for a change to planning controls or a rezoning) can in reality be blocked if a planning agreement is not offered.  There is no appeal to the Land and Environment Court when this happens, although there may be opportunities to seek an ‘rezoning review’ from a joint regional planning panel/Sydney planning panel/Planning Assessment Commission.

Unlike a development consent, the other parties to a planning agreement have an absolute right to veto any proposed modifications to the agreement.  There is no right of appeal to the Land and Environment Court.  This means that once a planning agreement is in place, the only checks-and-balances on the way that a local council or other agency behaves (under the planning agreement) must come from the terms of the planning agreement itself.

How have planning agreements been used?

Developers typically will consider entering into planning agreements when:

• a planning agreement is necessary to overcome some merit issue with a proposed development (eg an inadequate off-site intersection or the provision of an environmental offset);

• there is no existing contributions plan and there is an unarguable need to supply a range of public infrastructure to accommodate a large development;

• there is a need to commit to various land dedications (for schools, environmental conservation, roads, etc) in order to secure a rezoning; or

• the planning/consent authority is saying that a proposed rezoning or development application will not progress (or progress well) unless a planning agreement is offered.

Developer industry groups have been critical of the way in which many local councils have been using (or misusing) planning agreements.  In essence, developer representatives have argued that (in many instances) planning agreements are being used to simply tax perceived profits, rather than overcoming infrastructure or conservation problems.  For example, many developers have found that once an offer is made, the Council may simply ask for more money — often for example a 50% share in the profits of the development — and will threaten to otherwise stall or oppose the planning proposal entirely.

A planning agreement that is motivated by a desire to capture developer or landowner profits is informally called a ‘value capture’ deal.  Not all planning agreements have to be about ‘value capture’.  In fact, until recently, almost all planning agreements were not about ‘value capture’, but were simply about ensuring that adverse impacts from proposed development were appropriately controlled and mitigated.

The best succinct analysis of the problems with ‘value capture’ arrangements were set out in the Federal Government’s independent Henry Tax Review in 2010.  Some of the review’s findings were as follows:

• In general, infrastructure charges will operate more effectively if they are set to reflect the cost of infrastructure, not to tax the profit of development.

• Applying infrastructure charges through simple flat levies can sometimes reduce housing supply. Where the charge exceeds the cost of providing infrastructure, it acts like a tax and can discourage development. This is more likely to occur where the size of the charge is set relative to the developer’s capacity to pay (rather than the cost of infrastructure).

• To operate effectively, value capture taxes need to isolate the increase in value attributable to the zoning decision or the new infrastructure (as opposed to general land price increases at the local level). This is often difficult since the value of land will move in anticipation of a change in rezoning.  Sometimes this can occur many years before the rezoning.

• A value capture scheme may encourage the public sector to generate revenue through additional zoning restrictions or delays in land release.

• Where rezoning is linked to ‘value capture’, it is likely to stop land being developed to its most productive use — at least in the short run.

The draft practice note

A limited view of ‘planning benefit’

The new draft practice note is written on the basis that new development only delivers a ‘planning benefit’ if it delivers something that exceeds ‘the benefit derived from measures that would fairly and reasonably address the impacts of particular development on surrounding land’.

To be clear, the practice note works on the basis that a proposed development that would merely offset its own adverse impacts does not have any ‘planning benefit’.  This is an idea that has been popular in some bureaucratic and political circles in recent years, but it sits poorly with more conventional notions of town planning.

Traditionally, the planning system has seen the supply of new development as delivering ‘planning benefits’ if it meets strategic planning goals.

For example, conventionally, the planning benefit of new housing was understood to include:

• reducing or avoiding a potential undersupply of housing (with improved affordability outcomes as a result);

• increasing housing choice;

• boosting living standards; and

• providing an opportunity to better locate housing relative to jobs and transport.

Under this conventional approach, it would not matter how much money the developer made in delivering the development, so long as there was no unacceptable impact.

However, the new draft practice note only recognises the existence of a ‘planning benefit’ when a proposed development is used to finance improvements to a locality that more than offset the development’s adverse impacts.

Similarly, the draft practice note is written on the assumption that:

• the only ‘public benefit’ that a development delivers is ‘the benefit enjoyed by the public as a consequence of a development contribution’; and

• a ‘net community benefit’ only arises if it is associated with the provision of ‘off-site planning benefits for the wider community’.

There is no explicit recognition of the inherent planning benefits of development whose adverse impacts are appropriately managed.

Fundamental principles

The practice note sets out some ‘fundamental principles.  These include:

• ‘Planning decisions may not be bought or sold’.

• ‘Planning authorities should not use planning agreements as a means of revenue raising, to overcome spending limitations or other improper purposes’.

• ‘Planning authorities should not be party to planning agreements in order to seek public benefits that are unrelated to particular development’.

• ‘Planning authorities should not … attribute disproportionate weight to a planning agreement’.

• ‘Planning authorities should not improperly rely on their statutory position in order to extract unreasonable public benefits from developers under planning agreements’.

Conduct that is a ‘misuse’ of a planning agreement

The draft practice note identifies conduct that would be a ‘misuse’ of a planning agreement:

• Where ‘a planning authority seeks inappropriate public benefits because of opportunism or to overcome revenue-raising or spending limitations that exist elsewhere’.

• Where ‘a planning authority allows the interests of individuals and small groups to demand particular public benefits, which otherwise outweigh the public interest’.

• Where ‘a planning authority takes advantage of an imbalance if bargaining power between the planning authority and the developer’.

However, this does not stop a planning agreement from extracting benefits from a developer that exceed those required to offset the adverse impacts of a development.  Conduct is only regarded as improperly ‘taking advantage’ of a developer if the level of extra benefits sought is ‘unreasonable’.

Safeguards

The practice note says that ‘safeguards’ must be implemented to ‘protect planning agreements from the natural suspicion that changes to environmental planning instruments and development consents can be bought by the highest bidder’.

Perhaps the most significant ‘safeguard’ is the ‘generally applicable acceptability test’.

The key elements of the ‘generally applicable acceptability test’ are as follows:

• Planning agreements must be reasonable.

• Planning agreements must be directed towards ‘proper legitimate planning purposes’.

• The development contributions provided by a planning agreement must not be ‘wholly unrelated’ to the development.

• Planning agreements must meet the expectations of the public, protect the overall public interest, provide a reasonable means of achieving the desired outcomes and protecting the community ‘against planning harm’.

Partial profit capture is OK

The draft practice note expressly endorses the idea that planning agreements may involve ‘capturing part of a development’s profit’.  This means that profit capture is regarded by the practice note as a ‘legitimate planning purpose’ (as per the ‘generally applicable acceptability test’ above).

It says ‘planning benefits’ (ie the benefits that exceed measures required to offset a development’s impact) should not be secured if they could be ‘considered to be a form of taxation on development for revenue raising’.

The draft practice note explains how to distinguish between legitimate efforts to ‘capture’ development profits and illegitimate ‘revenue raising’.  It says that:

• Any contributions that are extracted (in excess of those required to offset the adverse impacts of the development) must not be ‘wholly unrelated’ to the contributing development.

• Planning agreements should not be used to ‘capture windfall gains in connection with the making of planning decisions, in particular in relation to changes to planning instruments’.

• Developers have an ‘entitlement to a ‘share of development profit’, provided that ‘the new development is appropriately serviced’ by infrastructure. The developer’s ‘share’ of the profit must not drop ‘below a point where the development is no longer feasible, the development may not proceed and benefits would not be realised’.

• The method of apportioning infrastructure costs must be clearly set out, justified and ‘ensures the developer an entitlement to profit that enables the development to proceed’.

• Proper investigation and consideration of development feasibility and capacity to pay is carried out, preferably on an ‘open-book’ basis, if raised as an issue by the developer.

• Planning authorities should not use any bargaining power they have as regulatory authorities ‘to force developers to enter into planning agreements providing any windfall gain on the terms sought by the planning authority’.

• ‘Planning authorities should consider all applications for planning proposals, development consents or modifications on their merits. The unwillingness of a developer to offer to enter into a planning agreement related to land value increase should not be a reason why a proposal is refused.’

This last point is probably the best news for developers in the draft practice note.  It means that current local council policies that explicitly seek to secure a share of land value uplift are not supported.

However, value capture can still be pursued under the draft practice note, it just means that attempts to capture value should not be expressed in terms of changes in land value.  For example, they may be expressed in terms of:

• a monetary contribution for a particular item of public infrastructure; or

• a monetary amount per unit of floor space or dwelling.

In order to show that any proposed value capture is unreasonable under the practice note it will probably be necessary for most developers to provide the local council with a feasibility analysis basis on an ‘open-book’ basis.

The draft practice note does not deal with the two most sensitive issues that are likely to arise in any ‘open-book’ consideration of development feasibility.

Firstly, how to value the land in the feasibility analysis.  Typically a developer will want to value the land based on the price at which the developer has/will acquire it.  Traditionally, planning authorities will value land based on (what often is) a lower threshold, that is, the value of the land at its current use (which in some circumstances, can be next to nothing).

These figures are often different.  This is because a long-term landowner sometimes has the capacity to withhold land from the market until a development premium can be extracted.  This may prove the biggest point-of-conflict between individual developers and local councils under the practice note (unless the issue is addressed before the document is finalised).

This will be of prime concern to developers, as they typically need to agree a price with the existing landowner before they have sat down with the local council to negotiate a planning agreement.  In the light of the new practice note, developers may want to consider whether the price paid to a landowner can be made contingent on the level of ‘value capture’ extracted from a planning agreement.

Secondly, the cost of capital in the feasibility analysis. The cost of capital (particularly the cost of equity) can vary between different developments and different proponents, based on perceived risk.

Often the cost of equity will have to be projected (or locked-in if mezzanine finance) well before planning agreement negotiations commence (for example, when the land is being assembled).  A developer may face a disproportionate ‘value capture’ burden if a local council subsequently takes issue with the cost of equity in the developer’s feasibility analysis.

Out-bidding other developers, planning ‘incentives’, density bonuses

Despite the draft practice note’s condemnation of the buying and selling of planning decisions, it does actually approve that very conduct in two circumstances.

Firstly, the draft practice note says that planning authorities may be faced with competing applications each accompanied by offers to enter into planning agreements offering contributions that exceed those required to offset impacts.

The practice note says that in such cases ‘it may be perfectly rational’ for the planning authority to approve the proposal which offers the ‘greatest’ level of development contributions.

Secondly, the draft practice note explicitly says that it is acceptable for planning agreements to be linked to ‘planning incentives, density bonuses, planning trade-offs or the like’.

While the details of any scheme should ‘preferably’ be contained in a local environmental plan or a development control plan, this is not essential.

There is nothing in the draft practice note to stop:

• local councils setting artificially low dwelling yields (or height or floor space ratios) in new or evolving precincts; and

• linking the realisation of the actual intended yields to a commitment by developers to enter into planning agreements.

Such arrangements are already in place at Green Square and Macquarie Park.

The draft practice note does say that benefits under a planning agreement should not be exchanged for a variation under a development standard under clause 4.6 if:

• the variation is not justified on planning grounds; and

• the benefit under the planning agreement is not directed towards achieving the planning objective of the relevant development standard.

In our view, this is effectively saying that if (for example) a planning agreement is to be used to justify a variation in the floor space ratio control, the planning agreement might need to address an infrastructure constraint that had led to the imposition of the existing floor space ratio maximum.

Multiple landowners

The draft practice note says that: ‘Where there is a need for public infrastructure across a development area with a range of land owners, a contributions plan maybe more appropriate because it simplifies transactions and has a clearer underpinning strategic planning.’

Setting contributions project-by-project or locality-wide

The draft practice note says that it is not appropriate for a planning authority to prioritise site specific planning proposals on the basis that they provide an opportunity to capture windfall gain.

Instead the draft practice note favours undertaking precinct, centre or LGA scale strategic planning initiatives.

Development consent conditions

The draft practice note says that ‘planning agreements should never be used to require compliance with or re-state obligations imposed by conditions of development consent as it may create unnecessary duplication’.

The draft practice note will not be legally binding

Remarkably, the state government is not proposing to make compliance with its practice note mandatory for any local councils or state government agencies (even when it is finalised).

Despite the broad powers available to the Minister for Planning, the draft direction merely requires local councils to ‘have regard’ to parts of the practice note.  The direction will not even be issued to state government agencies.

Local councils will be free to adopt their own policies that are inconsistent with the practice note.  Each time they negotiate a planning agreement they will need to consider the practice note, but will have the discretion, if they wish, not to follow it and instead follow their own local policy.

For development applications, there are existing statutory protections that, in some circumstances, will protect proponents from being shoehorned into unreasonable planning agreements.  These provisions will remain and can be enforced by the Land and Environment Court in appropriate circumstances,

When rezoning or changes to planning controls are being pursued, proponents wishing to challenge a local council’s approach to planning agreements have no right to appeal to the Land and Environment Court.  Instead they will be at the mercy of the complex and uncertain rezoning review process which is overseen by (in Sydney) the Greater Sydney Commission and (in the rest of NSW) the Department of Planning and Environment.

Only time will tell how good (and how interested) the Commission and the Department will be at ensuring that the new practice note (once finalised) is applied as intended.

Submissions

The draft practice note is out for public comment until 27 January 2017.  More detail is here.