by Ian Rowson
The concept of an option is one that has become increasingly widespread during the 1980s. There are few, for example, who are not acquainted with the significance of “share options” in financial packages for key executives and managers. Although options to acquire real property are a key weapon in any developer’s armoury, they are governed by a complex of rules and case law which are not always readily comprehended.
Many of the problems that arise from the use of options for assembling large development sites or securing strategic land are different from those that arise in options in leases, although some of the same principles apply. This article will consider some of the legal, commercial and practical difficulties that arise from the use of options in these circumstances.
Why an option?
To understand why options have become widely used by developers in securing development sites it is necessary to consider the legal nature of an option as opposed to other methods of securing development land.
An option to purchase is an offer to sell, irrevocable for a stated period until a stated event, made by a landowner to a developer, which the developer is entitled to convert into a concluded contract to purchase on giving the prescribed notice and otherwise strictly complying with the conditions on which the option is made exercisable. As an option is an estate contract it must be granted in writing. Prior to September 27 1989 this was to comply with section 40 of the Law of Property Act 1925 (LPA 1925). However, this has recently been repealed and replaced by section 2 of the Law of Property (Miscellaneous Provisions) Act 1989 (LP(MP)A 1989). Section 2(1) of the Act provides that the contract must be in writing and all terms which the parties have agreed must be in one document or, if there is an exchange, in each document. An option allows a developer the flexibility to secure sites while negotiating for planning consent, preletting the proposed development or arranging any funding.
The distinction between an option and a conditional contract is that in the latter case a developer will be bound to proceed as soon as the condition precedent has been satisfied. Thus, if the market retreats between the date of the contract and the date of satisfying the condition precedent the developer will still be obliged to complete the purchase at the agreed price.
All other methods of securing sites, such as outright purchase, tender and auction, suffer from the difficulty that a developer has to pay too much money “up front”.
The flexibility of an option for a developer can be demonstrated by the assembly of a greenfield site for a large out-of-town retail park. If a developer needs to secure several parcels of land for his development then each parcel can be secured by way of an option. Once the site has been secured in that way the developer is then free to pursue his application for planning permission.
At the same time, the developer can negotiate the preletting and funding of the proposed development. The agreements for lease with the prospective tenants can be drafted so that they become unconditional upon the developer securing a satisfactory planning consent for the whole development and purchasing the whole site.
The developer will thus be able to secure the site, prelet the proposed development and secure its funding while limiting his commitment to option fees, professional fees and the cost of obtaining planning permission.
General principles
An option can always be granted by the holder of a legal estate in land. Although different rules apply if an option is to be granted by a trustee, a tenant for life or personal representatives.
In the case of settled land, section 51 of the Settled Land Act 1925 (SLA 1925) provides that a tenant for life may grant an option whether or not for valuable consideration at a price agreed at the time of granting the option provided it is exercisable within 10 years and the price is the best that can be obtained.
These powers are extended to trustees by section 28(1) of the LPA 1925 (as amended). Furthermore, under section 39 of the LPA 1925, personal representatives are granted the same powers as a tenant for life and trustees for sale are empowered to grant an option.
Usually a fee is paid for an option: indeed there is very little incentive for a landowner to enter into an option without a substantial option fee being paid. In most cases the amount of the option fee will be linked to the likelihood of obtaining satisfactory planning consent, and within a certain time-scale.
In the case of an option being used to secure a long-term strategic development where huge acreages may be involved, it is likely that the option fee will be very substantial, and may run into hundreds of thousands of pounds. Where a number of options are used to secure a large-scale development site the fees paid will relate to the importance of each parcel in the context of the development as a whole.
If an option is to be underhand then it has been established since the case of Mountford v Scott [5] Ch 258 that a purely nominal consideration will suffice.
It should be borne in mind that stamp duty may be payable on an option in the light of George Wimpey & Co v IRC [5] 2 All ER 45 and therefore in appropriate cases a certificate of value should be included in the option.
If a long-term option is to be granted, the Perpetuities and Accumulations Act 1964 may apply. By section 9(2) of the Act options to purchase for valuable consideration (other than options to purchase reversions in leases) should be limited to a period of 21 years.
However, under the “wait and see rule” contained in section 3(3) of the Act an option which infringes section 9(2) can be saved if it is actually exercised within the 21-year period.
An option creates an open contract when it is exercised, unless there is a provision to the contrary (see generally Re Crosby’s Contract [9] 1 All ER 830).
Under an open contract there will normally be implied such conditions as would be implied in law, but in practice it is usual for an option to incorporate a specific set of conditions.
A reference in an option to a set of conditions “in force from time to time” would probably fail to satisfy section 2 of the Act. This is because the conditions would not be in existence at the date of the contract. Furthermore, because of section 2 any option should be signed by each party and exchanged.
There should always be a provision requiring the landowner to deduce proper title as required by section 23 of the LPA 1969 or section 110 of the Land Registration Act 1925 (LRA 1925).
A critical element of an option is the time-limit within which it can be exercised. Invariably, time-limits in an option are of the essence because an option amounts to a species of privileges for the benefit of the party upon whom it was conferred, and it is for that party to comply strictly with the conditions stipulated for its exercise, per Willmer LJ in Hare v Nicoll [6] 2 QB 130.
An option securing a greenfield site will usually be drafted upon the basis that there will be an end date (of, say, 10 years) coupled with a right for the developer to exercise the option prior to that date.
In most circumstances the trigger point for its exercise will be the grant of planning permission for the proposed development. Invariably, an option will provide that any such planning permission must be upon terms that are fully satisfactory to the developer (in respect of which he will have sole discretion).
A developer is required, however, to be reasonable in exercising that discretion: Gordon D C v Wimpey Homes Holdings Ltd (1988) The Times June 24 (which was, however, a Scottish case and would be of persuasive authority only in an English court).
An option will usually provide that it must be exercised in writing. If the option does not specificially provide for the mode of exercise then it should be exercised in accordance with section 196 of LPA 1925 (see New Hart Builders v Brindley [5] Ch 342. Any terms which are conditions precedent to the exercise of the option must be strictly observed, West Country Cleaners (Falmouth) Ltd v Saly [1966] 2 All ER 270.
Often an option may be dependent upon determination of a planning appeal, which may take a considerable time. Any option should therefore provide that it may be exercised any time up until seven weeks after determination of the appeal. This safeguards a developer against exercising the option prior to the six-week period within which an aggrieved party may appeal to the High Court under section 245 of the Town and Country Planning Act 1971 (TCPA 1971).
A point that has been overlooked in the past is that an option must be registered (as a C(iv) land charge in the case of unregistered land and by lodging a caution in the case of registered land). A recent example of a case where an option was held to be void for non-registration is the case of Mobil Oil GB Ltd v Phillips [9] 1 WLR 888.
It is not common to find a provision in an option that it must be registered within a specified time period.
It is likely that a developer will lose the benefit of an option if it is not registered within that specified time period.
Finally, in the light of the recent changes in legislation, it is important for a developer to ensure that the purchase price is deemed to be inclusive of any VAT which may be payable. This is to safeguard against VAT being payable on top of the agreed price, in circumstances where the developer may not be able to revert the tax.
Options to purchase at a percentage of market value
In the case of land with long-term development potential a developer will often negotiate an option on the basis that the price will be an agreed percentage of its open market value (OMV). This is very common in the purchase of large areas of land for residential development.
The percentage that a developer will pay will almost always depend upon his assessment of obtaining planning consent, and within what time-scale.
The landowner and developer have to assess the degree of risk in obtaining planning consent. If a developer’s planning consultants form the view that a particular site is likely to be released for a particular use within the short term (say, five years) then a developer will pay a higher percentage than if planning consent is likely to take 10 or 20 years to obtain.
It is prudent to bear in mind that policy can change very rapidly. The current Government’s about-face on environmental issues demonstrates how policy can change dramatically with the appointment of a new minister. Nowhere has this been demonstrated more dramatically than in the recent rejection of the proposals for a new town at Foxley Wood in Hampshire.
If a developer envisages that a planning battle is likely, then this will influence the price he is ultimately prepared to pay. Furthermore, even if an appeal is successful, it may be conditional upon a developer entering into a section 52 agreement which may require very substantial financial commitments by way of planning gain.
The option will usually provide that the developer will apply for planning consent at his own expense. It is essential for a developer to retain control over the timing of his application for planning consent, as a premature application can be very damaging. Furthermore, the option should permit the developer to appeal and also require the landowner to enter into any statutory agreement (eg pursuant to section 52 TCPA 1971 or section 278 of the Highways Act 1980) which might be necessary in order to procure the grant of planning permission.
If a development is likely to require trunk road improvements which necessitate a developer entering into a section 278 Agreement with the Department of Transport, the developer must actually be in a position to call for a conveyance of the land required for the highway works from the landowner. This is as a result of recent guidance issued by the Department of Transport and the Welsh Office in relation to the founding of trunk road improvement and is a critical factor to be taken into account when drafting an option.
A developer will usually seek to impose an obligation on the landowner to assist fully at all stages of the planning process subject to the developer keeping the landowner advised of the progress of the application and any appeal.
The crux of an option to purchase a site at a percentage of OMV is the formula for calculating the OMV of the site with the benefit of planning permission.
A practical basis for determining the OMV is by reference to the RICS Guidance Notes on the Valuation of Assets, the second edition of which was published in 1981 and which has recently been revised (“The Red Book”). This defines the OMV as being “the best price at which an interest in the property might reasonably be expected to be sold at the date of valuation on the basis of five assumptions, namely:
(i)a willing seller;
(ii)a reasonable period in which to negotiate the sale, taking into account the nature of the property and the state of the market;
(iii)that values remain static during the period;
(iv)that the property will be freely exposed to the market; and
(v)that no account will be taken of any additional bid by a purchaser with a special interest”.
The option should provide that the purchase price to be paid will be a percentage of the OMV so assessed. If the surveyors of the parties cannot agree the OMV within a specified period there should be provision for determination by an arbitrator/independent expert who should be required to make his determination within a reasonable time of being appointed.
It is essential for a developer that the OMV is linked to the developable acreage of the site. The developable acreage should take account of all parts of the site which are developable, but should exclude land allocated for major road improvements (eg a relief road), areas to be dedicated as public open space, and major drainage works (eg balancing ponds, sewage treatment plants etc), amenity land, sheltered or community housing etc. In most instances such facilities will already have been offered by a developer as part of the planning gain for obtaining consent for the development proposed. If such areas are taken into the equation the developer will be effectively paying for the planning gain twice.
The option should provide that the calculation of the OMV shall take account of the cost of providing satisfactory access to the site. It should also provide for the cost of obtaining all necessary third-party easements (eg private drainage easements) to be discounted, including the cost of diverting or putting underground any service installations and any other payments made to statutory undertakers.
An option which provides for the OMV to be calculated in the manner suggested should satisfy the legal requirements of certainty and ensure that both parties achieve a fair price for the site. Furthermore, a market price valuation assessed in accordance with the principles contained in the “Red Book” is likely to satisfy the requirements of a funding institution as security for a loan.
Although it is important that the price mechanism in an option must be certain, the courts have recently shown a tendency to give business efficacy to the arrnagements of commercial parties. In Sudbrook Trading Estate Ltd v Eggleton [2] 3 WLR 315, the Court of Appeal held that if the machinery for ascertainment of the purchase price broke down it would substitute its own to ascertain a fair and reasonable price.
The more liberal approach was taken again in the recently reported case of Corson & Others v Rhuddlan Borough Council (EGCS July 14 1989) in which the court stated that “if it could so balance matters that without violation of essential principles the dealings of men may so far as possible be treated as effective” then it would do so.
Assignments and dealings with options
An option should specifically provide as to whether it is to be assignable or personal to the grantee. A grantee can assign the benefit of an option either by express assignment or implication in the absence of any such provision, see Griffith v Pelton [8] Ch 205. However, the recent case of Briargate Developments Ltd v Newprop Co Ltd [1989] EGCS 146 shows that even when a landowner’s solicitors insert such a provision in an option the provision may still not protect the landowner’s interest.
Legally, an option constitutes a “chose in action”. Accordingly, to “perfect” the assignment of its benefit written notice must be given to the grantor. By section 136(1) of the LAP 1925 until such notice has been given the assignment will be imperfect and the assignee will be unable to enforce it against the grantor. In Briargate Developments Ltd v Newprop Co Ltd [9] EGCS 146 a provision in an option making it personal to the original grantee failed to protect a grantor who had an entitlement to share in future profits. Although the benefit of the option could not be assigned to a third party the Court of Appeal held that when the option was exercised an entirely separate contract arose, and the grantee could complete a subsale without paying to the grantor its share of the profits. A possible solution might be for a grantor to register a restrictive covenant to protect such arrangements.
The case is of significance because during the boom of the late 1980s it had become increasingly common for speculators who had an option to purchase to sell on the property comprised in the option at a profit before the option had been exercised, which effectively happened in the Briargate case.
Any developer entering into any agreement with a party whose only interest is an option should be aware that, whatever agreement is entered into, it will not create a proprietary interest in land. A developer’s rights in the event of any future breach of the agreement will be limited to a personal action for damages against the party with whom it has contracted. Furthermore, the agreement cannot be specifically enforced against the original landowner, nor can it be protected by registration.
Conclusion
It may therefore be seen that although the use of options may play a key part in any developer’s strategy, in assembling large development and housing sites the complexities to be considered are many.
While the use of options in the property sector is likely to become even more popular in times of high interest rates and a sluggish economy, the area presents a potential minefield and it is only those who are well advised and aware of the latest “wrinkles” that are likely to emerge unscathed.
