Option Agreements | Commercial Property
Have you recently found the perfect piece of land for your new development and want to ensure it is not sold out from under your nose while you are gaining planning permission? Or perhaps you have invested in a development project that you know will reap large profits. How can you secure a right to purchase the property once the venture is complete so you can maximise on your investment?
Get yourself an option agreement.
What Is An Option Agreement?
An option agreement is an agreement made between a landowner and a potential purchaser of their property. In simple terms, both parties enter into an agreement, in return for a non-refundable sum of money, the potential purchaser of the land has a legally binding option to buy at a certain date or within an agreed time-frame, or after completion of a certain event (for example after obtaining planning permission).
It is a point for negotiation when drawing up the option agreement whether the non-refundable deposit will be taken off the final purchase price of the property.
Aside from the examples in the opening paragraph, other situations which may give rise to an option agreement being put in place include:
• If a developer wishes to purchase any land adjacent to their existing development project site in the future in order to extend their venture.
• If the land being developed is sub-divided among owners, a buyer can buy up the full site piece by piece by obtaining option agreements from the individual owners.
There are four types of option agreements:
a) Call option – where a buyer has the right (but not an obligation) to buy the property from the seller.
b) Put option – where the seller has a right (but again, not an obligation) to sell the property to the buyer.
c) Cross option – the buyer receives a call option and the seller, in return, gains a put option.
d) Reverse option – occasionally these types of options are used to secure an overage payment (more on overages below…). Here the seller receives an option to purchase the property back after the ‘trigger’ event occurs if the overage payment is not forthcoming. The resale price will reflect the increase in value of the land as a result of the ‘trigger’ event (e.g. planning permission being granted).
In accordance with recent(ish) legislative changes (i.e. the Perpetuities and Accumulations Act 2009), option agreements which came into effect after the 6th April 2010 can be for any length of time, and the duration should be negotiated between the purchaser and the seller. Ensure you do negotiate this point or else the option on the land will be viewed as indefinite….not ideal from a seller’s point of view. Any agreements signed before the 6th April 2010 must be exercised within 21 years of the option being granted.
The Advantages of an Option Agreement.
For the Developer
• Securing an option agreement minimises your risk. If obtaining planning permission takes longer than expected, you can be confident that you have a legally binding agreement that prevents the seller from getting frustrated and selling the land to another buyer (see here) regarding an article outlining all the planning terms a planning commission committee member may have to consider, it may evoke a little sympathy depending on what kind of day you have had).
• You may be able to secure the final purchase price of the property in the option agreement. This can be a major advantage for agreements that span years rather than months because if land value increases, you are only bound to pay the contracted price.
• An option can be registered, securing your potential investment.
For the Seller
• If the property market is experiencing a downturn, you are assured of an interested buyer at some point in the future.
• You will normally receive a non-refundable deposit in exchange for the option.
• In certain circumstances the option agreement can include an overage clause, enabling you to claw-back additional money after the sale has completed.
The Importance of Accurate Drafting
Unlike pre-emption agreements, that simply give the prospective buyer the right of first refusal if the vendor decides to sell, an option agreement is a legally binding contract. Therefore, do not be surprised that should you (or the purchaser, if you are the seller) succeed in completing the event on which the execution of the option depends, you will actually have to buy or sell the property, even if other circumstances have changed.
The key to avoiding any “oh no what have I done!” moments is to ensure the drafting of the option agreement is as watertight as a submarine. The following conditions should be covered in a good agreement:
• The duration of the term of the option
• The amount of land included in the option
• The condition or conditions which must be met for the option right to be executed
• The amount of the deposit and payment terms
• Any extension on the duration of the option if applicable
• The final purchase price of the property if applicable
• A disputes resolution procedure
• Details of how each party may terminate the agreement under certain conditions
For security you need to register a call option agreement with HM Land Registry. A notice of the option agreement will be put on the title stating the potential buyer has a right over the land if the event needed to execute the option takes place. In the case of a pull option, the execution of the agreement is driven by the seller, therefore the buyer has no exercisable rights over the land so there is no reason to register this type of option agreement.
All vendors want to receive the best possible price for their land. However, if your land will only be worth its maximum value after a certain event, then you need to include a provision in the sale contract for an overage payment to be made once the agreed occurrence sets off the increase in the value of the property.
Examples of events that can be agreed by the seller and the purchaser that can trigger overage to occur are:
• There is a potential for future planning permission being granted on the land.
• Surplus profit being made by the purchaser after development of the land has been completed.
• The seller had to sell the property at a lower value due to an issue regarding the land which needed to be resolved for the proposed development to be viable (i.e. flood risk) and remedying the situation was less expensive than predicted.
The public sector often refers to overage as ‘claw-back,’ where, in the event that they sell land at a discount, that discount can be “clawed back” if certain ‘trigger’ events occur at a later date.
Securing Overage Payments
You can secure an overage payment by using one or a combination of the following methods:
• Placing a restrictive covenant over the land.
• Using a guarantee or bond.
• Imposing a mortgage or charge over the property.
• Acquiring a seller’s/equitable lien over the property.
• Freehold right of re-entry (the property reverts back to the seller of the overage if payment is not made).
• Positive covenant and restriction.
Notoriously complex, overage agreements require expert drafting to ensure that there are no nasty surprises down the line. And the surprises can be extremely nasty indeed. For example, in Ministry of Defence v County and Metropolitan Homes (Rissington) Ltd, the parties neglected to consider the possibility that the developer would not demolish all 37 houses on the land in question. Because they only demolished 35 and turned two properties into a shop, the developer had to pay a total of nearly £1 million pounds in overage.
The golden rule: when in doubt, don’t leave it out!
With accurate drafting, option agreements and overage can provide both developers and land owners with security no matter how unpredictable the property market may become in the future.
Have you had any notable experiences regarding option agreements or overages? We and others involved in commercial property would love to hear about them. Feel free to comment below and share your experience and wisdom.