This article explains the use of options, conditional contracts and pre pre-emption agreements. It tells you how and when to use them.
Why use a right of pre-emption or an option?
Prospective purchasers and vendors of land often want to 'lock in' the other party to the deal for obvious reasons. This is done by using either an option or a conditional contract or a pre-emption agreement.
Pre-emption rights
A right of pre-emption means a right to buy in priority to any other buyer.
So I might agree to sell you land to grow vegetables, but I also think one day you might sell it to someone who might get planning permission for six houses. The simplest way for me to make sure I have the benefit of any future uplift in value is to add a few paragraphs to my sale contract that sets down my rights in the event that you should ever try to sell.
Those paragraphs set out that if a seller appears, you have to tell me and give me evidence of the terms agreed provisionally. I then have the chance to step into the buyer’s shoes, either at the same price or at some other price, fixed specifically or by formula. For example, my price could be the price at which I sold to you, an index linked price or maybe something greater.
In practice, pre-emption rights are commonly cleared by you and I getting together informally and agreeing that I get paid out in cash when the next sale goes through. That is because my circumstances have changed and all I want is the uplift in value, not the actual land.
Generally, the seller sets out the terms of the deal and so the buyer has little power to object to the pre-emption right being included as part of the sale. The seller includes a pre-emption right because it is simpler than using a separate option agreement and less complicated than inlcluding other terms in the sale agreement that might prove to be wrong or inappropriate at a later date.
Options
Under an option to purchase agreement, the option holder has the right to buy the land at a later date under a set of specific terms.
The option holder is the person who buys the option from the owner of the land, and usually the person who initiates the deal.
Subject to terms, the deal gives the holder the opportunity to take action and increase the value of the seller's land before committing to buying it.
During that time, the seller agrees not to sell the land to anyone else.
To compensate for that, the holder pays the landowner a price.
The terms of the agreement are likely to include:
The timeframe within which the option must be exercised (the time in which the holder must buy the land).
The exercise price - what the holder must pay the seller of the land on exercise.
Options are most commonly used when the holder wants to obtain planning permission but does not want to buy at a price that reflects the increased value in case planning permission is not granted.
The holder may wish to exercise the option and then build his houses himself, or he may wish to sell to a third party without finding the money. Option agreements therefore often contain extensive and sometimes complicated provisions relating to the terms of settlement when the option is exercised.
Another common variation is for the exercise price to be based on a formula relating to the increase in value of the land through planning permission having been obtained.
The possible variations are limited only by the imagination of the parties.
Conditional contracts
A conditional contract is a sale subject to a condition. That condition may ”happen” in a matter of days or weeks, or even years. It could be the registration of a foreign subsidiary into which the purchase will br placed, or completion of some other deal, or the receipt of permission to develop.
A conditional contract should be used only when the condition is very likely to be satisfied, leaving the only variable as to the time. A conditional contract gives most certainty to the seller. The price is fixed, the deal is done. He just has to wait for the condition to click into place.
If the condition becomes complicated or further arrangements are needed on top of the condition, the arrangement becomes more like an option and an option agreement is more suitable.
Registration
An option, a right of pre-emption and a conditional contract are all "estate contracts" in law and can be registered against the land so as to make the land inalienable without clearing them somehow.
However, an option agreement is binding for no longer than 21 years from its date.
Tax considerations
Tax may be payable on the formation of an option or right of pre-emption in respect of land transactions.
Note, any later exercise of an option or right to pre-emption will give rise to a separate land transaction chargeable to tax in its own right. Although the exercise is a distinct transaction, it will be linked to the earlier grant of the option or rights of pre-emption.
Options are taxable even if the seller can discharge his or her obligation either by entering into a land transaction or in some other way, for example by payment of money.
At the time of the formation of the option or right, tax is charged on the option price at the rate applicable to that price.
If and when the option or right is exercised, tax is charged on the price for the land in addition to the option (or right) price at the rate applicable to the total price.
So although it seems like the purchaser has to pay twice, he is later given a credit for any tax paid at the formation of the option or right.
The grant of an option is not the acquisition of a major interest. So a property option agreement in itself is not notifiable to the Revenue unless there is transaction tax to pay.
However where the grant of an option is linked with its exercise may mean that the option becomes notifiable when the option is exercised.
Further information and documents
Next, you might like to read about buying land using options or strategies when using option agreements.
You may want to download one of our property option agreement templates.