Option agreements for land and property: finer points
The first article in this series discussed what options are and why they are useful for property developers. This article cover some finer points on their use.
Use a document written in plain language
Most land owners that a developer will approach will not know about the benefits of using option agreements. It is likely that you will have to explain how they work and how they benefit both sides. You will probably also want to present a document that does not look complicated, with which both sides can be confident that they know what the deal is.
However, you want to make sure that your interests are fully protected. Choose an agreement that contains terms that cover as many of the contingencies and risks for your deal as possible. Because we use plain English, all Net Lawman documents are comprehensible to most non-lawyers, so your land or property owner is not likely to be put off easily.
Option or conditional contract
Next, decide whether you want an option or a conditional contract. The difference is as follows:
An option ties the seller, but gives the option holder complete freedom to buy or not buy, without having to give a reason.
A conditional contract is different in that the contract is firm and binding on both parties from the beginning, subject only to the condition being satisfied.
An option is usually the most flexible instrument for the buyer, particularly in a situation where there are several unknown variables. (You cannot have a conditional contract if you are unable to identify the conditions!)
A conditional contract protects a seller by preventing the buyer from avoiding the contract if the expected condition is satisfied. An example where an option is usually used, is when an option holder wants to tie down a seller of land while he obtains planning consent. So long as the satisfaction of the condition is in the hands of the buyer, the seller does not need to worry about the buyer wandering away. If that buyer gets his consent, he will be knocking at the seller's door with the money.
An example where a conditional contract may be appropriate is: suppose the Department of Transport is discussing a new road through the seller's land. The road will take land for which the seller will be compensated, but the buyer sees that a ten acre site will end up adjacent to an industrial area and may well be re-designated as industrial land with a value ten times greater than current value. In this case there is nothing that either party can do to make the re-designation happen.
The buyer wants to buy and to tie the seller to him, but only if the land is re-designated. The seller also wants to sell, and he also wants to avoid the buyer deciding that he can do a better deal later, or walk away from it completely. So he wants something binding. He will go for a conditional contract. The condition is of course, that the land is re-designated as industrial. The contract binds the buyer to buy if the re-designation happens, whether he still wants it or not.
Our conditional contract document contains all the terms you might need. We also offer a number of option agreements. All agreements can be found here.
The starting point is our standard, non-assignable one version. It includes for example:
- a director's guarantee, in case the seller is a company
- a list of seller’s warranties as to the current planning status of the land
- seller's indemnity
- provision for buyer to nominate the purchase to someone else
- inclusion of any unregistered rights over adjacent land
A common problem in an option negotiation is the timing. The option holder does not want to commit money and time to increasing the value of the land, only to find his option has expired before he is ready to buy. Suppose the option holder depends on borrowed money to complete his purchase: he cannot borrow until his lender is sure that the full value is in place. So, while the option holder may be quite happy to complete, knowing for sure that his formal planning consent will be through in a week, if he cannot find the money before the option expires, he is simply handing a large windfall to the land owner.
However, the land owner wants to tie up his land for the shortest possible time. He also wants a payment for the option which reflects the fact that his hands are tied for that time. So it is easier for the option holder to negotiate an option for one year than for five years.
One way round this dilemma is to provide a "second bite at the cherry", through an extended option. How this works is that the original agreement provides for the extension of the last exercise date, but usually, only against a substantial additional payment. The land owner has a good profit for the extra time, and the option holder has the choice (no compulsion of course) of whether to abandon the option and take his loss, or pay the extra because he is pretty sure that an extra period will see him home and dry.
Provision for a time extension is useful when it is likely that the option holder will be better able to assess the chances of achieving what he wants at some later date. He may be able to negotiate a low price for an option for one year, enabling him to make investigations and test the water, with a higher price for say a further two years, when he is reasonably confident of success.
Another common problem is that neither side knows what the land will really be worth on the last date for exercise of the option. Planning issues are rarely cut and dried. It is likely that some compromise will be needed by the option holder from his preferred scheme. He may have to build less, or change the scheme, or improve nearby roads. The land owner wants full value, but the option holder does not want to commit to a scheme he may never see. There are two possible solutions.
In a clear case, it may be possible to devise an exercise price at various levels depending on the outcome. In that way the option holder pays roughly the same proportion of the end value whatever the outcome. This can be covered in the agreements by specifying a base price and one or more additional prices, depending on the outcome.
Another alternative is to have the land valued by a professional valuer at the exercise date and for the option holder then to pay the proportion of that value which was set out in the agreement. The only issue here is to identify a valuer trusted by both parties. This is preferable to merely providing for a joint appointment at the time of exercise.
Next you may be interested to read about option agreements and rights of pre-emption.
Please note that the information provided on this page:
- Does not provide a complete or authoritative statement of the law;
- Does not constitute legal advice by Net Lawman;
- Does not create a contractual relationship;
- Does not form part of any other advice, whether paid or free.
We would love to hear what you think about this article and how we could improve it. Please do let us know. However, we shan't be able to reply to your specific questions. If you have a question about a document, please contact us.
If you have noticed a bug or a mistake on this page, or just want to give us feedback, we'd love to know. Nothing is too small or too big. Send your message on this feedback page.