What is an Option Agreement?

The most common type of option agreement (known as a “Call Option”) is a type of contract where the Seller/Landowner grants the Buyer an exclusive right to buy a piece of land or property at an agreed or determined price, within an agreed time frame, and subject to any other agreed terms.

Crucially, the Buyer is not obliged to exercise the option, but has the right to do so if it chooses. The Seller, on the other hand, is legally bound to sell the property to the Buyer if and when the Buyer chooses to exercise the option.

Options are often favoured by Buyers due to the flexibility which an option gives. They are usually easier, quicker, and cheaper to negotiate than other types of contract used for the acquisition of development land.

Key points for buyers to consider

• Extent of the property – the extent of the property which is covered by the option should be carefully considered and accurately defined within the option agreement. The extent of the property may be fixed or variable, and an accurate plan should be used to identify the property where possible.
• Option fee - the Buyer can be asked to pay the Seller a fee (sometimes a nominal amount and sometimes a material amount) in return for being granted the option. This fee is typically non-refundable, though it may be deducted from the purchase price if the option is exercised.
  
  Option fees can often be a symbolic £1.00 given the value and cost of the Buyer’s other obligations which may be included within the option. The Buyer’s payment of the Seller’s legal fees (or a contribution to those costs) can often be agreed instead of an option fee.
• Price or method of determining price – in addition to any option fee, the option agreement will set out the price payable for the property if and when the Buyer chooses to exercise its option. The option agreement should specify the price or the method for calculating the price. The price can either be a fixed amount or based on an agreed formula (such as market value at the time of exercise, for example).
  
  If a variable price is agreed, Seller’s will often wish to agree a minimum price. The use of a variable price mechanism will complicate the drafting of the option, and careful consideration should be given to those provisions. Where a price is variable, the parties will often not wish for the option to be exercisable until the price has been agreed or determined by a third party expert.
  
  Buyer’s may seek to deduct certain costs from the price – such as legal fees and planning costs (as well as any option fees that may have been paid). The price is usually paid in pounds Stirling on completion by way of consideration, but other non-monetary consideration can also be used. Using non-monetary consideration will cause additional complication, and care is needed to ensure the relevant provisions are drafted carefully.
• Deposit – an option agreement will usually provide for a deposit to be paid on or shortly following exercise of the option. The deposit is usually five or ten percent of the price and may be held in the same way as any other deposit used within property transactions.
• Option period - the option agreement will define the period during which the Buyer can exercise its right to purchase. Extension provisions are often agreed (beyond any initial fixed period) to allow sufficient time for the Buyer to conclude its process for obtaining planning permission, submit additional planning applications and/or planning appeals or to allow any judicial challenge periods to expire once planning permission is granted).
  
  Seller’s will usually require an ultimate long stop date – being the date after any agreed extensions that the option period will terminate.
• Seller co-operation - access to the property for the Buyer to conduct due diligence is crucial. The agreement should include provisions allowing the Buyer access to undertake inspections, surveys, testing and assessments etc. The Seller will often require the Buyer to make good any damage caused by such access.
  
  The Seller may also be asked to refrain from undertaking activities which may prejudice the Buyer’s ability to obtain planning permission or which may render any future development more time-consuming or costly. The Seller may also be asked to refrain from submitting its on planning permissions for the property or nearby land, and be required to support (or not object) to any planning applications submitted by the Buyer.
  
  The Seller will often be required to keep the property secure and free from unauthorized access and use.
• Buyer’s obligations – option agreements may include provisions setting out the Buyer’s obligations such as requirements to engage with pre-application discussions with the local planning authority and/or submit a planning application and may set out whether or not the Buyer may or is required to submit a planning appeal in the event of a planning application being refused.
• Assignment – the option agreement may allow the Buyer to assign the benefit of the option to a third party (whether connected or unconnected to the Buyer) if the Buyer decides not to complete its purchase. This will allow another buyer to step into the position of the original Buyer.
• Transfer / relationship with retained land – The option agreement should include provisions which address the future relationship between the property and any land retained by the Seller on completion such as the imposition of covenants, grant and reservation of rights for each parcel and future management arrangements for any shared, access services or amenities.
  
  These provisions can either be addressed within the drafting with flexibility where needed or can be prescribed by annexing an agreed form of transfer deed to the option agreement. It is worth giving these arrangements detailed consideration at the outside to avoid uncertainty or disagreement in the future.

Benefits of an Option Agreement for a buyer

• Risk mitigation - the buyer is not compelled to purchase the property. The initial exposure for securing the option can therefore be limited to the option fee (which may only be £1) in addition to the costs of any commitments which the Buyer agrees within the agreement. This reduces the financial risk, especially if the Buyer is uncertain about the project’s profitability or viability.
• Market flexibility - if the market improves during the option period, the Buyer has the right to purchase at the pre-agreed price (assuming a fixed price has been agreed). This could result in substantial savings and additional profits in an improving market.
  
  Conversely, if the market or conditions become less favourable, the Buyer can elect to walk away from the transaction without further financial commitment.
• Timing - flexibility within the option period may allow the Buyer to dictate the timing for purchase to suits its commercial requirements. The flexibility within the option period may also allow the Buyer additional time to secure funding and/or discharge planning conditions / prepare for commencing construction promptly following completion of the purchase.
• Profitable assignment – if the Buyer has the right to assign the option agreement, this allows the Buyer to receive a payment from the ultimate purchaser resulting in profit for the Buyer without needing to purchase the land.
• Site assembly – option agreements are a useful tool if a Buyer is assembling a site made up of multiple parcels of land owned by different parties. The option agreement allows a Buyer to avoid committing to purchasing any of the land until all the land required to make the project viable is secured.
  
  Option agreements can be a quicker and cheaper route to securing property when compared to a conditional contract.

Is an Option Agreement appropriate?

An option agreement is generally a Buyer’s preferred method of securing property with development potential, but where planning permission has not yet been granted.

That said, there are alternative structures for acquiring land with development potential such as a conditional contract, unconditional contract, promotion agreement or a joint venture arrangement.  Use of overage/claw back may also be worth consideration.

The key to achieving a successful land option agreement is to ensure that key terms are clearly and properly considered and accurately drafted to ensure that a balanced approach is taken to address the practical, commercial and legal interests of each party whilst giving the Buyer time and flexibility to secure planning permission or other  key components needed to deliver the development of the property. To navigate these complexities, consulting with legal advisers who specialise in development can save considerable time and money, and is recommended at an early stage in the process.

Our Development & House Building Team specialises in acting for developers, land traders, landowners and funders in connection with the acquisition, disposal and funding of development sites across the country as well as advising on construction and planning arrangements and plot sales.

Contact us on [email protected] to learn how the team can assist you throughout the development process.