06 Apr Option Agreements: What Property Investors Need To Know
We act for many seasoned South Australian property investors who often seek our advice about drafting option agreements with a view to selling or purchasing land.
Occasionally, we are asked to advise less experienced landowners or prospective purchasers of land around the suitability of option agreements for them.
Whether you are a seasoned or inexperienced property investor you need to be aware of some of the pros and cons of option agreements as a means of selling and, in particular, buying land.
It is sometimes necessary and helpful to break down the concept of an option agreement to fully understand its legal elements and effects.
What is an option?
Options can be used in relation to any asset class (for example, shares or licences) but the focus of this blog is options in relation to land.
Options allow parties to enter into an agreement (called an option, usually in the form of a deed or contract) to sell or purchase land at a future point in time, requiring minimum upfront commitment in terms of payment of money or risk in terms of being bound by an enforceable contract.
Very simply, rights granted under a put and call option are a future right to compel a vendor to sell land (the “call option”), or a purchaser to buy land (the “put option”).
A call option is where the purchaser has a right (but not the obligation) to buy the land from the vendor.
A put option is where the vendor has a right (but not the obligation) to sell the land to the purchaser.
As options are rights, there is no actual agreement to sell and buy the land.
Instead, the parties (called the grantor and grantee or option holder) promise to each other that if the option is exercised, the parties will then will enter into a binding contract for the sale and purchase of the land.
Keeping one’s options open
In our experience, call options are often used by property investors and developers.
The classic example is the elderly landowner with a large parcel of land who agrees to enter into an option agreement with an investor who plans to develop and sell the land for a profit.
The investor knows that the planning consents will take some time, so the investor agrees with the landowner to have an option period of a few months in consideration for which the landowner receives an option fee. This could be a few thousand dollars.
The option fee may be non-refundable if the developer does not go ahead and exercise the option, or it could form part of the purchase price if the developer does exercise the option.
A win-win situation, or so it may seem.
Warning: beware boiler plate option agreements!
There is no standard form option agreement so there is the tendency for investors to use template agreements thinking that one agreement that was successfully used in one investment will be just as useful in a subsequent investment.
But as we should know there is a risk in doing this even for the experienced developer.
Here are some tips and traps for young and old players when it comes to option agreements:
The landowner will be the vendors (or the grantor). The other party will be the purchaser (or the grantee or the option holder). You’d be amazed how often novices get this wrong!
The land must be specified including the correct title reference and all relevant improvements. Again, real difficulties can be apparent if there is a discrepancy between the description in the option agreement and in the sale contract.
This must be clearly expressed in the option agreement and problems can arise in the construction of the agreement if there is a dispute as there often is when it comes to money.
The starting date and the finishing date must be specified. The option lapses if the purchaser does not exercise the option on a before the finishing date.
Exercise of option:
The option agreement should spell out how the option holder gives notice, invariably in writing, to the vendor of the exercise of the option within the option period.
The option holder should protect their interest in the land by lodging a caveat as soon as possible in the option period. The option holder may or may not have a caveatable interest in the land. The agreement should clearly express that the option holder has a caveatable interest in the land by virtue of the option.
The option agreement will probably allow the option holder to assign its interest in the agreement to a third party. It is in the option holder’s best interests to assign the interest but it may not necessarily be in the interest of the landowner.
The option agreement will almost invariably attract stamp duty (if there is money changing hands or a granting of a right, inevitably the State revenue authority will want a cut of it).
If the option is exercised, the parties then agree to buy and sell the land. But on what terms of sale? The sale contract should be an annexure to the option otherwise difficulties and disagreements can arise if the option is exercised.
The price must be express or ascertainable. Once again difficulties will arise if the terms are unclear as they sometimes are.
A vendor is obliged to provide a purchaser with a Form 1 Disclosure Statement setting out prescribed particulars with respect to the land. An option agreement should state that this must be done upon exercise of the option.
Option agreements are in some ways more technical and tricky than sale and purchase agreements, because they’re not templated and the fine print is often hidden, cavalierly adopted from another boiler plate document and otherwise legally unclear. Option periods are usually much longer than settlement periods, therefore the risk of something being misunderstood or going wrong seems to be much greater.
Take it from us: you should seek independent legal advice before you enter into an option agreement.
This blog is published by Di Rosa Lawyers for informational purposes only and is not considered legal advice on any subject matter. By reading and re-publishing the blog, you acknowledge that there is no solicitor-client relationship between you and Di Rosa Lawyers. This blog should not be used as a substitute for legal advice from a legal practitioner who specialises in the area and you are urged to consult us or seek your own independent legal advice on any specific issue or matter.