What is an Option Agreement?
An option agreement is a legally binding agreement whereby an optionor gives the optionee the exclusive right to purchase or lease a piece of land for a certain period of time. The time period is usually between six to twelve months, depending on the deal. This is most often done when a developer wants to tie up the land prior to making a major investment in the cost of feasibility studies, site plans and obtaining municipal approvals.
The sale or lease price is often either predetermined or based on fair market value. In some cases, the optionor may sell the property at a later date to a developer , at a higher price and may allow for the existing optionee to exercise their option at the same price. The key point is that options to purchase land are very common and will often take precedence over other opportunities. For instance, a commercial developer may wish to purchase land and develop a shopping plaza on it, but another party has already agreed to buy the land with the intention of developing a housing complex.
In that case, the developer will have to either pay more money for the land, knowing that they will make up the difference by selling the homes at a higher price or buy in as a partner.
Essentials of an Option Agreement
An option agreement is a legally binding contract. In order to be valid, it must contain the essential legal elements of an option. These are:
Option Fee
An option fee is the sum of money that the purchaser pays to the seller in return for the right to purchase the property at a later date. The amount is usually small, e.g. £50 or £100.
If the purchaser does not exercise their right to buy the property, the seller can keep the option fee. If the purchaser exercises their right, then the seller has to deduct the option fee from the purchase price.
Exercise Period
This is a limited amount of time in which the purchaser has the right to buy the property.
The length of the exercise period will depend on the reason for granting the option. Options that are given with the intention of the purchaser obtaining planning permission for development usually have an exercise period of more than two years. This is because it can take a long time for a developer to get planning permission and build on the land.
For other types of option, e.g. residential, a shorter exercise period of less than two years is appropriate.
Purchase Price
The parties need to agree on the purchase price because the purchaser will have a right to buy the property at that price during the exercise period. Failure to agree at this stage could mean that a vital element of the contract is missing, preventing it from being legally binding. The purchase price could be a fixed number or a number calculated in a certain way. It could also be substituted by something like a valuation at the time of the option being exercised.
The Impact of an Option Agreement on the Land Registry
As is the case with many property documents and agreements, an option agreement can affect the position regarding the title of the property. An option agreement is a unilateral agreement, meaning that it is binding on the seller but not the buyer. However, the buyer is granted an option to require the seller to complete a purchase of the property if the necessary condition(s) within the option are met. Sometimes, the condition may just be payment of the purchase price as notified by the buyer.
The effects of the agreement with the seller are, broadly speaking, that an option can be recorded at the Land Registry as a notice against the seller’s title. This is a matter for the buyer and seller (or their solicitors) to decide. The ability to record the option in this way is not automatic and the failure to do so will not invalidate the option. The recording of the agreement is more simply a precautionary measure to protect the buyer should he decide to exercise the option. While a purchaser can normally obtain a good title simply through the passage of time, registration can also protect the purchaser’s interest in the property ahead of any other parties who may have priority over that interest. An example would be a builder who had sold three plots on a housing estate without any obligations to build. The first purchaser could have exercised the option to develop the land within the agreed timeframe in advance of the other purchasers. This would have led to deprivation of the opportunity for sites two and three especially if the successful purchaser did not consent. The registration of the option would have ensured that the other parties to the transaction were aware of the arrangement between the builder and the successful buyer. Similarly, entry of the option would prevent (or at least reduce) the risk of the first buyer failing to meet the terms of the option and thereafter attempting to sell to a third party.
How To Register an Option Agreement
The registration of the option at Land Registry is a separate exercise from the exchange/ completion of the transaction for which the Option has been granted. Once the option has been entered into, it remains at large (albeit unchanged if fixed in time) until it is exercised or it lapses. If the option is to be exercised, this takes place once the terms agreed in the Option have been complied with and the appropriate Notice following completion of the transaction of sale/ purchase/ lease has been submitted to Land Registry.
A simple procedure must be followed to register an option. In the case of an Exchange of a Lease option a certain form is used. In the case of Sale and Purchase options, a different form is used. However, both are similar in content.
The On Line land Registry Application processes the Notice and Land Registry Office copy entries can be downloaded in about three days following receipt of the application.
Different rules apply to the parties who must be followed to the letter. Full details should be checked to ensure that the right party is making the application on the right form. It is worth mentioning that the restrictions applying to an Executor can apply to an Attorney acting under a Lasting Power of Attorney. An example would be exercising an Option to Dispose of Property.
Useful information:
Fee: The fee to apply for registration of an option is £40.00. Note, however, that in the case of a bulk applications, a discounted fee will apply. There are no refunds where the application is rejected for whatever reason.
Who can apply for registration of the option? This is complex. The party registering the option must have the correct power to do. A Seller would register a Sale option. An Original Lessee may register an Extension option. A Purchaser may register an Assignment option. A Lessee may register a Sub-Letting option. This is important and an application by the wrong party is likely to be rejected. Different rules apply to an Executor or an Attorney acting under a Power of Attorney. It is possible for separate parties to work together to register an option. To avoid delay, check who should be making the application and use the appropriate form.
Blocking an Option at the Land Registry: No one should try to do more than register an option. In order to prevent an adverse disposition of property, an application to register a restriction may be made. A notice will appear on the Land Registry Register indicating that the prescribed restriction exists (see note 4 in the application). The restriction means that any dealing with the property will be prevented for so long as the restriction has effect – usually until an Binding Contract is executed and completion of the sale takes place. When the restriction is entered on the Register, a seller is bound by it and cannot sell the property to anyone else unless the Buyer is also willing for their name to appear on the Register or they are in the process of buying the property. The only exception being a sale pursuant to an Administration Order.
Good news! The fee for registering an Option to Sell and an Assignment is the same as a Sale of a Lease, Extension of a Lease and a Sub-Letting. This means that if the opportunity arises to take an Option, there is no benefit in applying for anything other than the highest value option.
The Advantages of Registering an Option Agreement
There are many advantages to registering an option agreement at the Land Registry including the following:
Your legal right to purchase the land under the option agreement is protected against third parties, including any purchasers of the land you are intending to buy. It is public record so will be easy for your mortgage company / solicitor to check that you have an enforceable option which allows you to buy the land you are contracting to buy. It gives you further protection as it gives you a right to keep the title register up to date. So , for example if you became divorced your Ex may try to sell the land before you buy it. This can be dealt with by registering a restriction under s.40 Land Registration Act 1925 and the title does not have to be kept up to date. It is easier to market and/or finance your interest in the land if it is registered.
Common Issues and How to Resolve Them
The common challenge when dealing with Option Agreements and registration at the Land Registry is a reluctance by the Land Registry to be persuaded to enter a restriction in order to protect the interests of the Option Holder until after the exercise of the Option. Any restriction should ideally be registered when a valid Option Agreement is entered into so that the interests of the Option Holder cannot be sold off, given away or charged over.
To register the Option Agreement or a restriction which restricts registration of dispositions of land without consent of the Option Holder, Land Registry Practice Guide 8 states the position: "Applications to register options and pre-emption rights will be rejected as a matter of course. Option agreements create an equitable interest under an option agreement enabling the recipient to require the transfer of land in the future. An equitable interest under an option agreement is not registrable."
The Government is aware of this position and, following an inquiry on behalf of the Good Law Project into the remote witnessing of wills during lockdown (which was not supported by the Law Society), the Government is considering amendments to the Land Registration Act 2002 to allow restrictions to be registered to protect the interests acquired under an option agreement immediately upon entry into it. This will take some time.
In the meantime, you may need to persuade the Land Registry to register a restriction to protect your interests under an Option Agreement. Although the practice guidelines do not assist you in persuading the Land Registry to register the restriction you want, if you can establish that there is no practical difference between the two scenarios below, the Land Registry may agree to register a restriction that you require to protect your interest: Scenario 1 – An owner of land enters into an option agreement giving the Option Holder the right to specify the land office title number when serving notice of exercise of the Option. Scenario 2 – An owner of land sells a freehold interest and includes an option agreement which gives the buyer the right to specify the land office title number when serving notice of exercise of the Option.
Another possible deterrent to registering the restriction is that registration of the restriction will trigger the requirement under section 27(2)(a)(ii) of the Land Registration Act 2002 for payment of Stamp Duty Land Tax (SDLT) and Land Registry fees. Section 27(2) states: 27(2)A person must apply to register a disposition unless it is in an excepted category and, if he does not, he is liable to pay a penalty of £100.
This leads to the following dilemma. If you enter into an Option Agreement with one party which contains an Option, will you be taken to have made a disposition which requires registration and which is not an excepted category? The answer is no, however if you include a right in the Option to specify the title number to be used when the Option is exercised, you may be deemed to have made a "disposition" which is not an excepted category. This leads to you being liable for payment of SDLT and Land Registry fees.
The most straightforward solution is to ask your solicitor to prepare a side deed which grants to the Option Holder a right to specify the title number against which a restriction may be registered to protect their interest in the land. In the side deed, the parties inform Land Registry that they have entered into the Option Agreement (and/or the Overriding Agreement) and the parties agree that the restriction may be registered as a Class D(i) restriction in the register of the land.
Legal Considerations and Practical Tips
The implementation of a successful option agreement requires careful planning and consideration from a legal perspective, which carries with it a commitment of additional time and money from both parties. We would generally recommend that an experienced solicitor be instructed to draft an option agreement at the outset. However, if you do choose to draft your own option agreement, then you should at least consider the following provisions as mandatory:
If a seller is faced with an offer at or near the asking price they may forget that they are under an obligation to grant an option and delay doing so whilst they negotiate with the potential buyer as to the draft terms of the option agreement. They may even try to remove the obligation altogether or, more likely, within the option agreement itself.
The best practice is to manager this risk by ensuring that the agreement obliges the seller to grant the option on terms to be agreed and makes it a condition of the agreement to grant an option that it is in the same form or similar to an option agreement previously granted to the seller by any other option holder.
It is essential for sellers to ensure that the introduction of an option agreement does not trigger a need for any pre-emption procedure to other shareholders or chargees. In addition the implementation of an option agreement may well give rise to the need for the seller to obtain third party consents and to notify certain bodies of the grant of the option.
Case Studies – How Option Agreements Work
In a case decided in the First-tier Tribunal, the taxpayer owned a leasehold interest in a development in Camden which they were looking to redevelop. They were therefore in negotiations with a developer and the freeholder of the site. Following on from these negotiations, an option agreement was entered into between the parties which provided for a premium to be paid on the grant of a 250 year lease in respect of the redevelopment site (which also contained residential accommodation). The option agreement also provided that the option fee would be rebated in full against the constructive receipt of the premium in the event that the long leasehold interest was acquired. In the interim, the developer had also entered into negotiations with the freeholder of the site and on acquisition of the lease, the developer claimed that it was entitled to relief under TCGA s 241 (which provides relief where property is acquired by a company to be held to carry on a trade). The Tribunal found for HMRC on the basis that the option fee was not consideration given for the acquisition of the land but rather an upfront payment in exchange for the right to acquire the land at some point in the future. This outcome indicates that options are not always favourable for reducing capital gains tax . Indeed, given the Tribunal’s reasoning in this case, options can be of greatest value in protecting against adverse market movement rather than as a means of locking out potential competitors. This case should also be read in conjunction with BSI (Camden) Ltd v HMRC [2019] UKUT 246 (TCC) where agricultural property relief was denied on the basis that the owned land would, following its development, be held as a trading asset and relief would not apply on the basis that the conditions for relief provided in TCGA s 274 were not met. The Court decided that the land had instead been purchased for the purpose of realising an advantage in the overage payments rather than with a view to a genuine trade. A subsequent decision of the same Tribunal confirmed that BSI did not extend to "flip-flop" agreements. These are agreements whereby, the basis of the parties’ relationship, and any agreements made, are flipped following the grant of planning permission so that the landowner is able to claim refused relief. Although the taxpayer had attempted to rely on the entry into an option agreement with a builder with a view to developing the site, in reality the arrangements were "business as usual" and the claims based on agriculture relief and roll-over relief could not be claimed.
