Option Agreements, also referred to as buy/sell agreements or put and call option agreements, provide a party with the right, but not a definite obligation to buy a property or asset. They have a wide variety of uses, including for real property, businesses or business assets and as tools for succession planning. This article focuses on their use for real property (i.e. land and buildings).
What are the Different Options?
An Option Agreement can contain what is known as a put option, or call option, or both. These are:
- Put Option – this is where the seller has the right to compel a buyer to buy the Property.
- Call Option – this is where the buyer has the right to compel a seller to sell the Property.
- Put and Call Option – this may grant both parties the right to compel the other to buy or sell the Property. Usually these options would run consecutively – the call option first, and then the put option kicks in after the first option has expired.
How does it work?
An Option Agreement usually contains two main parts:
- The body of the Option Agreement, which outlines the terms on which the parties may exercise their option; and
- The sale contract as an annexure to the Option Agreement. The Contract will often have all details and terms finalised, including the Purchase Price and length of contract. On exercising an option, both parties will need to sign the agreed sale contract.
This is the most common method of exercising options concerning real property, however other mechanisms available depending on specific circumstances or type of agreement.
Option Fees and Deposits
The purposes and type of Option Agreement will determine what is a reasonable basis for requiring option fees or deposits to be paid. For example, an Option Agreement may provide that:
- The Buyer pays a non-refundable “Call Option Fee” of $10,000.00 in exchange for being granted a 6 month call option over the Property. The commercial basis for having a Call Option Fee is that the Seller is taking the property off the market for 6 months, without being guaranteed a sale.
- On exercise of the call option, the Buyer signs the Contract and must pay a 10% deposit under the Contract, and the balance of the purchase price on settlement of the Contract.
There can be adverse tax consequences of utilising a large non-refundable option fee, so it is imperative that consideration is given to the capital gains tax and GST treatment of option fees before the Option Agreement is entered into. There can also be the risk that the arrangement constitutes an instalment contract (read more about those here) if it is not properly prepared.
Where an Option Agreement is intended to be more mutually beneficial or grants both parties the right to compel the other to buy or sell (respectively), it is more common for the Option Fee to be a nominal amount (i.e. $1.00) with a full deposit payable under the sale contract on exercise of the option. This may avoid some adverse tax and duty consequences.
Triggers for Options
Option Agreements may have set time frames during which a party may exercise its option, or otherwise the option periods can be triggered by certain events (for example, the Buyer obtaining a development approval).
Option Agreements can also allow for the asset to be sold to another party on exercise of the option. This can be useful where the buyer has not yet determined or established the legal entity that is to acquire the asset. Use of an option agreement avoids needing to rescind a contract that doesn’t list the correct buying entity at the outset (to see more information about using the wrong entity see here).
Why use Option Agreements?
There are many reasons why Option Agreements can be beneficial or necessary. These include:
- Practical reasons – for example, where a property developer wishes to lock in the option to buy a property at a set price, but subject to its right to obtain development approvals for the land and determine a final buying entity; or
- Tax reasons for long sales – using an Option Agreement can defer tax or duty liabilities until a period more convenient for one of the parties, such as the next financial year for CGT purposes, or closer to the anticipated settlement date. A Option can be attractive compared with using a long term unconditional sale contract.
In summary, Option Agreements have a wide range of uses and may offer benefits over a sale contract alone, however there are a number of significant legal and tax issues that will need to be considered. Sale contracts and option agreements each have their limitations and you should always seek advice before entering into an arrangement concerning real property. We have extensive experience in this area.
Please contact our team today should you have any questions regarding Option Agreements or any other property related legal issues.