An option agreement is a contract made between a landowner and an aspiring purchaser. It gives the purchaser the right to buy land/property during a specified period, known as the “option period”. Option agreements are commonly used by developers, as entering into one allows a site to be secured while they obtain planning permission.
Once the developer has explored the site to the extent that it is confident that it would obtain a feasible planning permission for the intended development, it would exercise the option and proceed to purchase the site. Following exercise of an option (by the purchaser), the landowner is obliged to sell.
An option agreement will either contain a fixed purchase price or detail the mechanism (usually based on market value) by which the purchase price is to be calculated at the time the option is exercised. Once planning permission is obtained, a price notice may be served and the parties will enter negotiations to determine the price.
The price negotiation process can be time consuming and complex, as build costs and profits (if the purchaser is a developer) are usually factored in. Including a minimum price provision in the option agreement is useful. This guarantees a minimum price to the landowner. In worst-case scenarios, an expert may be instructed to assist in determining the purchase price. Provisions dealing with price determination and the appointment of an expert should be considered when drafting an option agreement to prevent any future disputes.
Types of option agreement
Call options
A call option allows a purchaser to call on the landowner to sell the property to them within the option period. Once the call option has been exercised, the landowner is obliged to sell the land to the purchaser. In this way, the purchaser is in control and can elect to exercise the call option once they wish to do so.
The purchase price of the property is usually calculated based on a percentage of the market value (at the time the option is exercised), taking into account any increase in value attributed to any planning permission that is obtained.
Put options
A put option can either be incorporated into a call option agreement or entered into by way of a separate agreement. Unlike call options, put options allow a landowner to exercise their right to oblige the purchaser to buy the property. In this way, during the put option period, the landowner has control as to when they will dispose of the property.
The terms of the sale are agreed in advance and should be detailed within the put option. The purchase price is usually a fixed amount, agreed between the landowner and potential buyer prior to completion of the put option agreement. The duration of a put option period is usually strict and limited, as it would be impractical for a purchaser to be bound by a put option for a long period. For this reason, put options are less common.
Developers tend to steer away from put options as they would be contractually bound to purchase a site in the event a landowner exercises their put option. This is regardless of market conditions and whether the developer has obtained planning permission.
Cross options
A cross option is a combination of both a call and a put option. Usually, this only permits the call option to be exercised if planning permission is obtained. Similarly, this only permits the put option if the call option period has expired.
Cross options can be used in a wide variety of circumstances. For example, a landowner may grant a developer a call option over a site so that the developer has security while planning permission is obtained. At the same time, the developer may grant the landowner a put option over a part or the whole of the site in the event that the developer does not exercise their call option within the option period.
Another example would be where a landowner grants a developer a call option and in addition they are also granted a put option to require the landowner to buy back the site in the event that the site (or part of it) is no longer required.
Reverse options
Reverse options are a mechanism sometimes used as a vehicle for securing an overage payment. In this scenario, a purchaser would buy a property and grant a call option to its seller, giving the seller the right to request that the purchaser sells the property back to it if a trigger event occurs. This is usually seen where a developer buys a site, obtains planning permission and the previous landowner has the option to buy the property back with the benefit of that planning permission, thereby benefiting from any increase in value.
In practice, this option is rarely exercised. Instead, it can be used as leverage whereby the landowner will release their option in exchange for payment (based on the increased property value).
Advantages for purchasers
Options allow a purchaser to secure a property while they undertake investigations and obtain planning permission. This minimises the financial risk to the intended purchaser while giving them time to organise matters such as funding and planning without the burden of an impatient landowner.
In the case of a call option, if it transpires that a property is not suitable for the intended purpose, the purchaser does not have to exercise their option to purchase. In addition, the purchaser is in control of when they exercise the option. A right of pre-emption should be granted (as opposed to an option) by the landowner if they wish to retain control of the property, as the buyer would not be able to force the landowner to sell.
Furthermore, if the purchase price detailed in the option is fixed and the market value increases — usually where the option period is for years, not months — the landowner is contractually obliged to honour the agreed fixed price.
Advantages for landowners
Landowners will usually have the benefit of a non-refundable option fee. This will vary depending on the commercial terms agreed. The option fee is payable on completion of the option agreement and is therefore retained by the landowner – irrespective of whether the purchaser exercises their option to purchase the land. Landowners also do not need to be involved in the planning or build processes, which is costly and time consuming. Once a purchaser has obtained planning permission, the property is likely to benefit from an increased market value. The landowner could then impose and benefit from an overage payment on the purchaser.
If a landowner has agreed a fixed purchase price and the property market is encountering difficulties, they are guaranteed the fixed purchase price in the event that the option is exercised.
However, there are a few disadvantages for landowners, the main one being that there is no guaranteed sale of the property. The option would also restrict the use and disposal of the property for the duration of the option period.
In the case of a call option, the purchaser is ultimately in control of when the option is exercised. This can be frustrating for landowners, especially if the option period is lengthy.
Drafting considerations
For an option agreement to be valid, section 2 of the Law of Property (Miscellaneous Provisions) Act 1989 must be complied with. Notwithstanding the legal requirements for a contract to be valid, a contract for the sale of land must be in writing, incorporate all terms that the parties have expressly agreed and be signed by (or on behalf of) each party.
Retirement Villages Developments Ltd v Punch Partnerships (PTL) Ltd [2022] EWHC 65 (Ch) highlights the importance of careful drafting. In this case, the landowner — Punch Partnerships — granted an option to Retirement Villages Developments in 2013, with a fixed purchase price and an option period of 30 months, which could be extended if conditions were met.
Punch Partnerships argued that the “end date” – defined in the option as the latest date of three separate events – had been met and sought rectification of said agreement on the basis that the drafting did not reflect the common intention of the parties.
However, the court disagreed and concluded that the terms of the option were clear, did not evidence a common mistake and should be considered on their ordinary meaning. As a result, the option agreement as drafted was upheld. This meant that the option period in practice had no definitive end date. When exercised, Retirement Villages Developments could purchase at the fixed purchase price.
In light of this case, unambiguous language is required when drafting option agreements to avoid inaccurate representations of the terms agreed by the parties involved. This case emphasised that the courts will not step in and imply terms in order to rectify a bad bargain.
Protecting an option agreement
As explained above, put options are in the control of the landowner and therefore the purchaser has no exercisable rights. For this reason, while there is no requirement to register a put option, call options are generally an equitable interest and therefore must be protected once granted to bind the landowner and relevant property.
In respect of registered land, once an option has been granted the legal interest should be registered at HM Land Registry to provide the potential purchaser with security. Call options are usually registered in the form of an agreed notice (using form AN1) or unilateral notice (form UN2).
Furthermore, a restriction should be applied for (using form RX1) as this will prevent the landowner from disposing of the property, usually without obtaining a deed of covenant from its disponee in favour of the entity benefiting from the option that the disponee will comply with the terms of the option agreement.
Standard form L restriction would usually apply: “No disposition of the registered estate by the proprietor of the registered estate, or by the proprietor of any registered charge, not being a charge registered before the entry of this restriction, is to be registered without a certificate signed by…”
In respect of unregistered land, a call option should be protected by way of
a Class (iv) land charge at the Land Charges Registry.
Sophie Crompton is a solicitor at Brabners
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Key points on agreement for lease, including landlord refurbishment works, tenant’s early occupation for fitting-out works, timings and completion
