Option Agreements: A Basic Checklist for Sellers

Option Agreements: A Basic Checklist for Sellers

Here we look at some of the fundamental points which should be covered when a land or property owner is considering entering into an Option Agreement.

1.”Call” or “Put” Option?

In the case of a ‘Call’ Option the Buyer has control as it can ‘call’ for (i.e. require) the Transfer of the property, usually on pre-agreed terms.

Sellers should be aware that their plans for the property may be restricted.

A ‘Put’ Option gives the Sellers more control:  they can ‘put’ the property on the Buyer,  i.e. by requiring the Buyer to purchase the property, again ordinarily on pre-agreed terms.

2.Option Period

In the case of a Call Option, Sellers should be aware that the property may be “sterilised” throughout the option period. For this reason,  Sellers should ensure that the Option Agreement includes a clear “long-stop” (or “drop-dead”) date.

(As an aside, a 2009 Statute disapplied the rule against perpetuities for Options, and so Options granted after 6 April 2010 need not specify a long stop date. Prior to this, a Call Option would be void if it was not exercisable within 21 years).

If the exercise of the Option is conditional on the Buyer obtaining planning permission, Sellers should ensure that any provisions which allow for the extension of the Option Period (for example to allow for the possibility of a judicial review period of a planning decision) are not “open-ended”.

3.Seller’s Encumbrances

If the Option Agreement restricts the Sellers’ freedom to encumber the property, the Sellers should consider whether the relevant provisions will hinder the Sellers’ plans for, and proposed dealings with, the property.

The Sellers may feel that they should during the Option Period be able to enter into rack-rented Leases of the property, in order to maintain its investment value.

If the Buyer wishes to impose restrictions on dealings with the property, a way forward may be to provide that any dealings with the property can be completed with the Buyer’s consent, on the basis that such consent will not be unreasonably withheld or delayed.

Sellers might also consider the possibility of being able to grant Leases which:

• do not exceed a specified length of term (for example, for no more than three/five/seven years)
• are contracted out of the security of tenure provisions under Part II of the Landlord and Tenant Act 1954, and
• include Landlord’s break options

4.Exercising the option

Sellers should ensure that the Option Agreement sets out a clear mechanism for the exercise of the option. Ideally, there should be a prescribed a form of notice to be served by the Beneficiary (i.e. the Buyer in a Call Option and the Seller in a Put Option) so as to minimise the risk of a dispute about whether the option has been validly exercised.

They should also ensure that the notice provisions are adequate. The notice exercising the Option does not have to be signed by both parties, because it is simply activating the Option,  and it is not a contract for sale itself.

5.Calculation of the price

Sellers should ensure that the Option Agreement sets out a clear mechanism for the calculation of the price.

If the price is to be based on a market valuation, the Sellers should consider:

• whether the valuation should take account of a planning permission (actual or assumed)
• linking the valuation to a known standard, for example the Royal Institution of Chartered Surveyors’ Valuation — Professional Standards ‘Red Book’. Ideally, the valuation mechanism and any assumptions and disregards by reference to which the valuation is to be made should be checked and with a valuation surveyor.
• how the Buyer’s costs (for example those incurred by or on behalf of the Buyer to obtain planning permission) should be treated
• whether the calculation should include some protection for the Sellers in the form of a ‘collar’ (so that the sale price cannot fall below a stated figure/price per acre/hectare)

The Option Agreement should always include expert determination/dispute resolution provisions.

If the price is to be a fixed amount, the Sellers should consider whether it should be indexed-linked (particularly where there is a lengthy Option Period).

6.Exercising the option over part of the property

If the Buyer can (in the case of a call option) choose to acquire part or parts (often called ‘tranches’) of the property, the Option Agreement should:

• make clear how the price will be calculated for each tranche
• define each tranche by reference to a plan
• provide (where necessary/appropriate) for the Sellers to reserve rights over any tranches acquired by the Buyer. (It may be appropriate to attach an agreed, separate form of transfer for each tranche).

If the Option Agreement permits the Sellers to grant Leases over the property before the exercise of the Option, Sellers consider the possibility that acquisition of a tranche could result in a ‘split reversion’ (i.e. where a Landlord, after granting a Lease of a property, disposes of his interest in part of the property by selling part of it to a third party. As a result of that dealing, the Tenant, who remains in occupation of the whole property under the original Lease, may find himself with two Landlords in respect of the different parts of the property).

In such cases it may (from both parties’ points of view) be best to restrict the Sellers’ ability to grant Leases, so that a Lease can only be granted over the whole of a tranche.

7.VAT on the Option Fee

In the case of a Put Option, the grant of the option by the Buyer to the Sellers does not transfer any equitable interest in land because the Buyer has no legal or equitable interest in the property at the date of the Option Agreement.

Therefore, and unlike the grant of a Call Option by the Sellers, the supply made by the Buyer in granting a Put Option (i.e. the option fee paid by the Sellers to the Buyer) does not follow the VAT character of the land. Instead, the supply by the Buyer is one of services, which will only be subject to VAT if the Buyer is either registered, or registrable, for VAT (i.e. a ‘taxable person’).

In the case of a Call Option, the option fee paid by the Buyer to the Sellers will be standard rated for VAT purposes if the property comprises a new or uncompleted commercial building, or civil engineering work.

For these purposes, ‘new’ means completed less than three years before the grant of the Option. An Option granted over an older building or land will be exempt unless the Sellers has elected to waive the exemption for VAT (and “opted to tax”).

If the Sellers have so elected, the grant of the Call Option will be standard rated and the option fee will attract VAT, unless the property comprises a building intended for qualifying residential or charitable use.

8.Registration of the Option

In the case of a Call Option, Sellers should bear in mind that, if the Option Agreement is protected at HM Land Registry by registration of an Agreed Notice, a copy of the Agreement has to be sent to HM Land Registry and it will be available for public inspection. This may compromise any confidential provisions within the Option Agreement.

If the parties wish to keep the terms of the Option Agreement confidential the Option should be protected by registration of a Unilateral Notice. (The Land Registry will not then require a copy of the Option Agreement).

A Put Option cannot be registered at the Land Registry because the Sellers are the registered proprietors, and the Buyer does not have any interest in the land unless, and until, the Sellers exercises the Option.

Sellers should be aware that a Put Option is a purely contractual right, and that it may be of little value if the Buyer becomes insolvent.

(This article is not intended to be comprehensive or to provide specific legal advice. It should not be relied upon in the absence of specific advice given in relation to particular circumstances.)