Option Agreements and Conditional Contracts: What are they?

As demand for development land continues to grow, property owners are increasingly approached with proposals involving option agreements and conditional contracts. These legal arrangements, while offering strategic advantages for developers, can carry long-term implications for sellers.

Increasingly, home and land owners are being approached by buyers to enter into option agreements and conditional contracts for the purchase of their properties.

Understanding the differences between option agreements and conditional contracts is crucial for not only buyers, such as developers, but also for the property owners who are effectively tying down their properties for what could be prolonged periods of time.

Both are popular tools in the world of development and this article will look to provide a brief overview of their key points and differences.

What is an Option Agreement?

An option agreement gives the buyer the right to purchase a property for a pre-agreed price or pre-agreed valuation method within a specified timeframe.

The seller agrees to give the buyer an exclusive option to purchase, but it is just that, an option. There is no obligation on the buyer to proceed with the purchase. It is essentially a right of first refusal for the buyer.

This makes option agreements an attractive tool for buyers, such as developers, who may wish to use the exclusive period to secure planning permission or obtain funding before choosing to commit to the purchase of the property.

If planning is granted, the buyer may choose to exercise the right to purchase on the terms which were previously agreed and set out within the option agreement. Alternatively, if planning is not granted the developer may choose to walk away.

Although the above is the most common instance where an option agreement may be used, it is important to note that the buyer may still choose to exercise the option to purchase even if planning is not obtained. They may even choose to not submit a planning application altogether and decide further down the line whether they want to exercise their option to purchase the property.

Irrespective of the buyer’s thought process, if the buyer is happy to commit to the purchase during the option period, they will serve a notice on the seller notifying them that they have exercised their option to purchase.

At this point, the option agreement becomes an unconditional contract which will dictate the terms of the sale.

As you will note from the above, the option agreement is flexible and can be tailored to suit various scenarios, however, the seller should note that once it is exercised by the buyer, the seller is obligated to complete the sale.

It is therefore imperative that prior to entering into an option agreement that legal advice be sought. Here at Judge & Priestley we can assist you in the negotiation and drafting of an option agreement.

The most common example of an Option Agreement in action would be:

If a developer believes a plot of land has development potential, they can approach a landowner to request that they enter into an option agreement.
The developer will typically pay a fee to the landowner for, what is effectively, a right of first refusal for a set period of time.
Provided planning is granted within the option period, the developer can choose to exercise the option and purchase the property.
Alternatively, for other reasons (such as difficulties in raising finances) they may choose to not exercise the option even if planning is granted. Equally, the developer may choose to exercise the option without obtaining planning permission first.
The buyer and the seller will then have to comply with the option agreement which will set out the terms of the sale touching on the deposit payable, the purchase price, and the date for completion among other considerations.

Key features to bear in mind when considering an option agreement:

No Obligation: the buyer has the option to purchase the property in question. There is no obligation on them to do so.
Tied down: option agreements will impact the seller’s ownership for the duration of the agreement. It will prevent them from being able to sell the property to another without the developer’s consent and depending on the way it is drafted may require the developer’s consent to any future remortgages during the option period.

What is a Conditional Contract?

A conditional contract is an alternative method to securing a right of first refusal over a seller’s property.

Unlike an option agreement, a conditional contract requires both parties to commit to the sale of the land, but the sale will only go ahead once a specific condition is met. In development, this condition is usually the grant of satisfactory planning permission.

As the grant of a satisfactory planning permission is the common trigger for these types of contracts, much care must be taken in defining exactly what represents a satisfactory planning permission.

For example, a developer may sign a conditional contract to buy land, with the contract stating that the sale will only go ahead if planning permission is obtained for the development of the land. If planning permission is refused, the contract is void and neither party are required to proceed.

If satisfactory planning permission is granted, the developer is then obliged to proceed with the purchase of the property on the terms set out within the conditional contract.

Key features to bear in mind when considering a conditional contract:

Obligation to Proceed: the completion of the sale depends on the condition being met (which in most cases is obtaining planning permission).
Legal Certainty: Once satisfactory planning permission is obtained, the transaction must go ahead.

Overage Provisions

Both option agreements and conditional contracts can include an overage provision, which normally provides for an increase in the purchase price in circumstances where planning is granted for a larger development than originally envisaged.

The form of overage provision can be quite complex and affects the way either type of contract is drafted.

Key differences between Option Agreements and Conditional Contracts

1. Obligation to Complete:
- Option Agreement: there is no obligation on the developer to complete the purchase, it is the developer’s choice as to whether they wish to proceed with the purchase.
- Conditional Contract: if the condition is met, the developer is obligated to proceed with the purchase.
2. Risk:
- Option Agreement: this is lower risk for a developer, as they can choose to not buy the property if planning permission is refused or if they do not hold the necessary funds to complete the purchase if planning is granted and their circumstances change.
- Conditional Contract: this is higher risk for a developer, as the deal must go ahead if satisfactory planning permission is granted, regardless of other circumstances such as the developer’s finances.
3. Control:
- Option Agreement: gives the developer greater control as they ultimately decide whether they want to proceed with the property purchase. The seller, on the other hand, must sell if the developer exercises their option to purchase the property.
- Conditional Contract: both parties are locked into the deal, therefore offering less flexibility than an option agreement. The developer must buy and the seller must sell if the condition is met.

Please note that this article aims to provide a summary of the above. It should not be relied upon as legal advice.

Written by George Nicolaou (Solicitor)

In our second article, we discuss the advantages and disadvantages of Option Agreements and Conditional Contracts for a Buyer Developer.

Please contact us on 020 8290 0333 or email info@judge-priestley.co.uk if you would like more information about the issues raised in this article or any aspect of Property Development Law.

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