In the first of two articles in this series, Partner Matthew Russell discusses the benefits of Put and Call Option Agreements and how they can work in your favour as an astute Buyer or Property Developer.
Put and Call Option Agreements (“Option Agreements”) are useful documents commonly used to facilitate real property transactions. Broadly speaking, they operate in the same way as a Contract of Sale, but their additional features are designed to result in more flexible terms for the parties.
By definition, Option Agreements provide the Buyer with an “option” to require the Seller to sell the property to the Buyer (known as a “Call Option”) and provide the Seller with a corresponding ‘option’ to require the Buyer to purchase the property (known as a ‘Put Option’).
If a party wants to exercise their particular option, they must do so in a specific fashion and within a pre-determined time-period. These periods are known as the ‘Call Option Period’ and ‘Put Option Period’ respectively. The Buyer is also usually entitled to nominate a third party to be the purchaser of the Property.
If either the Call Option or the Put Option is validly exercised, then a Contract of Sale (in the agreed form and usually attached to the Option Agreement) comes into effect with settlement scheduled to occur pursuant to the terms of that Contract. However, if neither option is exercised, the Option Agreement comes to an end, without a contract for the property being created.
As a Developer or a Buyer seeking to acquire property, Option Agreements are an excellent tool to:
- Lock the Seller into a binding agreement;
- Ensure a long settlement period, without being obliged to pay transfer duty early (i.e before settlement); and
- If prepared correctly and used thoughtfully, prevent situations requiring “double transfer duty” from arising for the purchase of the property in circumstances where:
- you wish to on-sell the property for a profit; or
- you’re unsure of the correct buying entity at the time of signing.
They also may contain conditions that the Buyer requires to be satisfied by certain due dates (and prior to settlement) for example, a Due Diligence Condition and/or a Development Approval condition.
A Due Diligence condition allows the Buyer to be satisfied with any searches, tests and enquiries that will assist in understanding the feasibility of its intended project. The Development Approval condition allows the Buyer to lodge a development application and obtain a satisfactory development approval from the local council. These conditions not only provide certainty that the Buyer can carry out its intended development at the site, but obtaining a development approval, which runs with the land, assists the Buyer in achieving a more favourable valuation for finance purposes.
A practical example of the operation of an Option Agreement
- A Developer has scoped out a parcel of land that he would love to purchase; it would be perfect to develop 20 residential town homes.
- However, he does not have the funds to settle quickly and would prefer a long settlement and to be satisfied with his due diligence enquiries and obtain a DA on the site, before he hands over any money to the Seller.
- He therefore requests the Seller enter into a Put and Call Option Agreement on the following terms:
- Purchase Price – $5,000,000;
- Subject to Due Diligence (“DD”) – 60 days from the date of the Agreement;
- Subject to obtaining Development Approval (“DA”) – 3 months from the date of satisfaction of DD.
- Call Option Period – 12 months from the date of the Agreement;
- Put Option Period – 14 days after the expiry of the Call Option Period; and
- Settlement Date – 30 days from the date the Contract comes into effect (i.e upon the exercise of the call option or the put option).
- The Seller agrees provided an initial deposit of $50,000 is paid on signing and a balance deposit of $200,000 is paid within two business days of the DD and DA conditions being satisfied. The initial Deposit is typically refunded if the Agreement is terminated under the DD or DA conditions.
- The above terms, mapped out on a timeline or “Gantt” chart, look like this:
- In this example, Mr Developer satisfies both the Due Diligence and Development Approval conditions by their due dates, and exercises the “Call Option” on 30 April 2023 (the day before the expiry of the call option period). This means the Contract comes into effect at that time and settlement is 30 days later.
- However, if Mr Developer satisfied those conditions but failed to exercise the Call Option, the Seller would have the right to exercise the Put Option during the Put Option Period. Mr Developer would then be required to settle on the purchase of the property 30 days after the exercise of the Put Option.
There are many complex concepts and issues to be considered when proposing to enter into an Option Agreement. You need an experienced property lawyer to help guide you through this process. Matthew Russell and his team are here to help.
Read the second part of this article which dives into the importance of ensuring Put and Call Option Agreements are drafted in your favour.
Think Option Agreements. Think Nicholsons.