Option Agreements are legal agreements between a landowner and a prospective purchaser of a site, generally a builder or developer. The option holder essentially has the option to purchase the site from the landowner at an agreed-upon price and within a specified time frame, if the option’s requirements are met.
An option agreement benefits both landowners and developers: the landowner benefits from the developer’s promotion of their site for development, while the developer benefits from some certainty regarding future pipeline delivery, typically at a discounted purchase price to reflect the planning risks. In this article, land option agreements, we take a look at the process involved and the options available to you.
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Option Contracts
A developer and a landowner can enter into an Option Agreement, which gives the developer the option to purchase the land (typically at an agreed-upon price, or at market value less pre-agreed deductions), as well as the ability to obtain planning, without the risk of being forced to acquire the land without the benefit of planning. Landowners may also benefit from entering into an Option Agreement because they can realise a greater price for their land without having to invest their own finances in acquiring planning.
How may developers benefit from option agreements?
The most frequent type of Option Agreement (referred to as a “call option”) aids a developer in determining the viability of a proposed property.
Often, in exchange for payment of an option fee, the developer retains the option to purchase the plot of land. The developer can then apply for planning permission, certain that even if the application is denied, he or she is not obligated to purchase the piece of land, but that if planning is granted and a viable project results, the developer has the flexibility to acquire the site on known terms.
An Option Agreement is registerable with the Land Registry by notice, which protects the developer in the event that the landowner sells the land to a third party.
What are the advantages of option agreements for landowners?
Landowners benefit from call options because they enable them to submit their land for development without having to navigate the complexity and costs associated with gaining planning permission. Additionally, landowners benefit since the price paid for the land under the option is typically determined by the site’s viability as a development site, and therefore the land benefits from a higher price reflecting of the planning potential.
Additionally, a separate type of Option Agreement (referred to as a “put option”) may be employed, which enables a landowner to compel a developer to purchase the land. While the landowner may be forced to pay the developer an option fee, the landowner is under no obligation to sell the land.
In contrast to a call option, a put option does not constitute a legal interest in the underlying asset and so cannot be registered with the Land Registry.
Identifying and avoiding possible pitfalls
Landowners frequently make the mistake of conflating option agreements and pre-emption agreements. The latter just grants the prospective buyer the right of first refusal in the event that the vendor decides to sell, but an option agreement is a legally enforceable contract. In other words, if you successfully complete the event that triggers the option’s execution, such as obtaining planning consent, you will be required to sell your land, regardless of whether other conditions have altered. This is why careful wording of the agreement is critical.
There are numerous risks connected with poorly worded option agreements, and the following are just a few of them.
Length of Contract
A normal option agreement lasts three to five years but can be extended if a developer’s planning application is still pending. A schedule outlining the developer’s responsibilities should be included to ensure that all parties understand what is anticipated and by when.
How is the purchase price calculated?
To avoid surprises, ensure that you understand how the acquisition price is calculated and whether deductions are made for useless portions of the land or whether these portions ‘enable’ the remaining development. Additionally, you’ll want to include language in the agreement requiring the scheme to proceed only if a minimum land take or minimum sale price is attained.
What is the Impact on unpurchased land?
Occasionally, a developer will wish to purchase land in phases (tranche development). Therefore, you must guarantee that the option agreement grants you the right to utilise the land freely while planning is sought and acquired. A tranche purchase can have a significant impact on when sale profits are collected, and this must be specified in the contract.
Third-party land interests
Consultation with other third parties may be required before proceeding with an option agreement. For instance, are there any portions of land that are subject to wayleave? Will you retain access to services following the completion of the land sale? Have you consulted your bank or the person who holds the property’s first charge?
Tax implications
Early involvement of your accountants and other professional advisers is critical to avoiding unexpected charges or tax penalties. The agreement must safeguard your right as the landowner to suspend or delay exercise of the option if the tax system changes significantly or adversely.
Negotiating the price of the option
Typically, the purchase price mechanism reflects a percentage discount from the market value at the time of exercise, with additional deductions for an option fee and planning promotion expenditures included. Negotiating a price can be challenging because no transaction occurs in which the market value is set by competing bids on the open market.
Therefore, negotiation must be entered into to determine the market value of the property by debating the value of the completed development, the development’s costs, and the developer’s profit. When discussing the value of a site, it is also necessary to consider local market conditions and comparable land deals. Following this bargaining process, the landowner and option holder might agree on a purchase price.
If the landowner and option holder cannot agree on a purchase price, the agreement should include measures for resolving disputes. This typically entails the nomination of an independent expert or arbitrator with sufficient experience who is also a chartered surveyor. The expert might be appointed directly by the parties or through the RICS.
How we can help
We have a proven track-record of drafting land option agreements. We will guide you through the process and ensure all checks are carried out swiftly and efficiently and we firmly believe that with the right solicitors by your side, the entire process will seem more manageable and far less daunting.
How to Contact Our Commercial Property Solicitors
It is important for you to be well informed about the issues and possible implications of drafting an option agreement. However, expert legal support is crucial in terms of ensuring a positive outcome to your case.
To speak to our Commercial property solicitors today, simply call us on 0345 901 0445, or click here to make a free enquiry. We are well known across the country and can assist wherever you are based. We also have offices based in Cheshire and London.
Disclaimer: This article provides general information only and does not constitute legal advice on any individual circumstances.
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