Whether you are a seasoned property developer or just starting out, committing to a land purchase is a big decision. You might have found the ideal piece of land to develop, but that’s just one hurdle. Unless the land is being sold with full planning permission in place, there is a risk that you might end up with something you can’t develop in the way that you want. Fortunately, you can minimise this risk through the use of option agreements or conditional contracts.
In this article, our experienced commercial property solicitors guide you through how option agreements and conditional contracts work. We explore some of the advantages and drawbacks associated with using these agreements and highlight any areas to watch out for.
We also consider some of the key terms that should be included so you have a better understanding of what is involved. Our aim to is to bring you clarity around these complex agreements and to help you make smarter property decisions when it comes to land acquisitions.
Contents:
- What is an option agreement, and how does it work in practice?
- What is a conditional contract, and how does it differ from other agreements, like option agreements?
- What are the pros and cons of using an option agreement and/or conditional contract for developers?
- What are the typical terms and conditions included in an option agreement and conditional contracts?
- What are some common pitfalls to watch out for?
- When should a developer consider consulting a commercial property lawyer?
What is an option agreement, and how does it work in practice?
An option agreement does exactly what it says on the tin. It gives you the option (in the form of an exclusive right) to purchase land from a landowner, typically for a predetermined sum and within a specified timeframe, but you are under no obligation to do so. You can simply walk away and let the agreement lapse if you choose to. The landowner, on the other hand, will be obligated to sell their land to you under the terms of the agreement if you decide to exercise the option. Option agreements typically require you to serve notice on the landowner when you want to exercise your option to purchase and pay a deposit (typically ranging from 5-10% of the purchase price). They also tend to include a long-stop date by which the option to exercise ceases to apply so that the agreement doesn’t tie the landowner in indefinitely.
Option agreements are often used as a strategic tool by property developers who may not be ready to commit to the full purchase, but don’t want to miss out. The option period, in a way, buys you time to carry out investigations and ensure that the land is right for your project before parting with your cash (although you usually have to pay an option fee to the landowner). Developers typically use this time to satisfy themselves on the viability of the project, for example, through conducting feasibility studies, obtaining planning permission, and securing finance. In terms of the purchase price for the land, it can either be an agreed-upon sum, or the option agreement can contain a mechanism used to calculate it later.
You might be wondering at this stage what’s in it for the landowner whose land is locked to someone who may or may not buy it. Well, first, there is the option fee, but these can sometimes be nominal sums. That said, the landowner does have the certainty of a fixed price if the land is purchased, and often, these encompass the enhanced value of the land with planning permission in place. The option agreement also means the landowner can take a passive role and let the developer do all the groundwork in securing planning permission.
What is a conditional contract, and how does it differ from other agreements, like option agreements?
As with option agreements, conditional contracts enable you as a potential purchaser to secure land exclusively for a certain period of time. In this scenario, however, you are legally bound to complete the sale if and when certain conditions are fulfilled. The conditions typically relate to the same things that a potential purchaser in an option agreement will be investigating before deciding to go ahead, for example, securing planning permission, obtaining other consents.
The main difference between the two is the obligation to complete the sale. In an option agreement, the choice is ultimately yours whether to proceed with the purchase, even if you are satisfied with your checks. In the case of a conditional contract, once the planning permission is in place, or finance secured, etc., under its terms, the sale must go on. You cannot back out at that point. The contract becomes unconditional. However, if the conditions are not met, then you are not obliged to purchase something that doesn’t meet your requirements. Against this backdrop, it is easy to see why conditional contracts may be more preferable to landowners who benefit from the certainty of a sale in certain events.
Conditional contracts also typically contain a long-stop date by which it can be terminated if the conditions have not realised. The landowner is then free to market their land to others. As with option agreements, the price at which the land must be purchased in a conditional contract can be a fixed sum that the parties have agreed on or a price mechanism. In terms of upfront fees, whereas option agreements can be nominal sums, conditional contracts usually require a 10% deposit, although this can be refunded if conditions are not met and the sale doesn’t complete.
What are the pros and cons of using an option agreement and/or conditional contract for developers?
Pros:
- Risk mitigation: If done right, the overall effect of both option agreements and conditional contracts is that you do not end up owning land that doesn’t meet your proposed development plans. Whether you have exercised an option to purchase because it meets all your checks or the conditions precedent are satisfied, you need only acquire the land when viable for your project. This eliminates a huge amount of uncertainty in committing to a purchase first and then trying to make it work for you.
- Flexibility: While option agreements inherently offer a lot more flexibility as the decision to purchase is ultimately yours, both tools offer a way out if things don’t go according to plan. With an outright purchase, there is no going back and unwinding the deal once completed if it doesn’t meet your needs.
- Exclusivity: Both option agreements and conditional contracts typically allow you to secure the property to the exclusion of anyone else, meaning that you can rest assured the property will not be sold or offered to anyone else for the period while the option / conditional contract is in effect. This means less pressure to make quick and sometimes uninformed decisions when competing with other interested parties on the open market.
- Minimise upfront costs: Although prices may vary, whether that’s the option fee or the deposit for a conditional contract, both mean lower initial upfront capital requirements.
- Price certainty: Especially in cases where you have agreed upon a fixed price, you can budget and factor these costs into your project finances and modelling accordingly.
- Control over processes: Although landowners tend to be more involved with conditional contracts, on the whole, the process of obtaining planning permission (or anything else) is driven by the potential purchaser/developer. This degree of control is important as you will be the expert here in most cases, and you want to be able to ensure planning permission is obtained for the specific needs of your project
Cons:
- Wasted expenditure: The obvious and primary concern for developers is investing significant amounts of time and money into something only for the purchase not to go ahead. This might be because you are unable to obtain satisfactory planning permission or some other consent needed to proceed. It may also be because the results of surveys and feasibility studies are unsatisfactory. Whether this means you decide not to exercise an option or a condition is not fulfilled, ultimately, it can be considered wasted costs. That said, many developers can view this as costs worth expending for the benefit of being able to walk away, rather than being left owning land/property that doesn’t meet your project’s needs.
- Time pressure: Developers might face time pressure to obtain planning permission and/or other investigations within the option or condition period. It is important to ensure this period is realistic and takes into account any appeals for planning permission refusals etc. when negotiating lengths at the outset. You can also negotiate extensions.
- Landowner control: While you may have secured the exclusive right to purchase the property, whether as an option or on fulfilment of conditions, the land is retained by the landowner in the meantime. This means you have to rely on the landowner keeping it in good condition between the time you enter into the option agreement or conditional contract and eventually acquire the land. That said, both agreements can be drafted to place obligations on landowners to do so.
What are the typical terms and conditions included in an option agreement and conditional contracts?
Conditional contracts tend to be a lot lengthier and more involved than option agreements. This is because they need to set out the conditions in detail, as well as the circumstances of the sale and purchase when they are fulfilled (which as we know is mandatory).
Both option agreements and conditional contracts will contain standard terms, including names and addresses of parties, details of the subject land, and the price/pricing mechanism for which it is to be purchased (when the option is exercised or the conditions fulfilled). Both agreements often include provisions that require the landowner to cooperate or facilitate activities by the purchaser, for example, in obtaining planning permission. It is also common for both option agreements and conditional contracts to contain some sort of dispute resolution mechanism, although again, conditional contracts tend to be a lot more involved because of what is at stake.
Specifics to option agreements include:
- Option fee: the non-refundable payment agreed upfront for the grant of the exclusive right
- Option period: the period during which the purchaser can exercise their option, circumstances in which it can be extended, as well as any long-stop date agreed so it doesn’t continue indefinitely.
- Option notice: the agreed form and method for serving notice on the landowner to exercise the option, the deposit payable, as well as confirmation that this will result in a sale and purchase.
- Planning submission details: for option agreements where planning is sought, this can be drafted widely or narrowly depending on what’s agreed between the parties. For example, it can either require the developer to submit an application by a specified date, or leave it to the developer to submit applications during the option period at its discretion (or somewhere in between).
Specifics to conditional contracts include:
- Deposit: the percentage of the purchase price to be paid on the date of the contract.
- Conditions: what conditions need to be fulfilled and when in order to make the contract unconditional. This includes who is responsible for making any applications, what is being applied for, in what circumstances it will be deemed acceptable/satisfactory, and whether an appeal can be made.
- Waiver: whether the purchaser can waive any conditions and go ahead with completion.
- Termination: in what circumstances the contract can be terminated, for example planning permission being granted subject to unacceptable planning conditions, if it becomes apparent acceptable planning permission is unlikely to be achieved either at all or within a specified timeframe, breach of obligations by either party etc.
- Operative provisions: that come into effect once the condition has been fulfilled and the contract becomes unconditional.
- Risk and Insurance: who is responsible for insuring the land and what happens with the proceeds of any insurance payout in case of damage both before and after the date the contract becomes unconditional.
What are some common pitfalls to watch out for?
With option agreements, it is important to allow enough time to conduct your investigations and be clear on when extensions are permitted to the option period, taking into account the long-stop date. If terms are unclear here, or the circumstances intended by the parties are not captured accurately, you may find that you are close to obtaining planning permission only to not be able to exercise the option.
Things can get a lot more complex with conditional contracts. The most common source of disputes is over whether a condition is deemed to be fulfilled and what amounts to ‘satisfactory’. A tension exists because landowners naturally want conditions to be drafted widely so that the contract can become unconditional and they get paid. As the purchaser/developer, on the other hand, it is important to try and keep these narrow and specific for your intended purposes. For example, if the contract is conditional on obtaining satisfactory planning permission, you want to be clear on what restrictions or planning conditions imposed by the planning authority will be deemed acceptable.
When should a developer consider consulting a commercial property lawyer?
Both option agreements and conditional contracts are complex, so it is wise to get a legal expert on board at early stages. We can help you right at the outset to decide on how best to structure the potential land acquisition depending on your unique circumstances, as well as negotiate and agree heads of terms. Importantly, as commercial property lawyers, we ensure you understand the risks and implications involved in these transactions, as well as your rights and obligations.
Our skills and expertise are indispensable when it comes to drafting and negotiating the terms of option agreements or conditional contracts. Vague and ambiguous wording or poor drafting can lead to expensive disputes further down the line. With a skilled and trusted legal advisor like Harper James on your team, you can rest assured we will be working hard to achieve favourable terms, and ensure the agreement aligns with your overall objectives.
If you need a commercial property solicitor to help you navigate option agreements or conditional contracts, or have any further questions about them, our friendly commercial property team is on hand to help.
