Options in Development – Part 2 – Terminology (1)

As you have already read “Options in Development – Part 1 – what is an option and what forms of options are there?”, you are now familiar with what Call Options, Put Options and Put & Call Options are. There is however a plethora of terminology thrown around in the circle of options which you may need to get your head around if you are to wheel and deal in this arena.

This article and our third article builds on the previous discussion of what an option is by explaining some of the common language used by option traders and property developers. Our fourth article from Andrew Pine solicitor will then tie in these first three articles and discuss how they often function in the real world. These articles do not however substitute for legal advice and you should obtain your own, should you wish to engage in any form of option documentation. Andrew Pine lawyer is experienced in option agreements and can advise you on any option queries you may have. Andrew Pine solicitor can be contacted on the details provided at the bottom of this article.

 

Option Fee

You have probably been wondering throughout this series so far- why would a Seller give the Buyer a right but not the obligation under a Call Option Agreement to buy their property for a fixed period of time at a pre-determined price? If they gave a Buyer this ability without anything in return, they would essentially be giving the Buyer a free kick to potentially buy the property under the market rate. A Buyer would be able to sign up an Option Agreement with a Seller and wait to see if the market value increased above whatever price is agreed, then essentially buy the property for this fixed price which may be below market value. If the market went up, happy days. If the market did not, the Buyer could just walk away. Well here’s the catch.

The Seller often (but not always) requires the Buyer to pay an Option Fee. This fee can either be payable when the Option Agreement is entered into, or over a period of time or when certain milestones are reached. The amount of this Option Fee can be either a high amount or a very low amount, as this is a commercial negotiation to be agreed upon between the parties. If the contract to purchase the property is entered into (either by exercising a Put Option or Call Option), the Option Fee does not necessarily form part of the Price paid by the Buyer to the Seller to buy the Property. It is a separate fee paid for entering into the Option Agreement – i.e. for the Seller giving the Buyer the right but not the obligation to purchase the property at a particular price.

Another aspect of an Option Fee which is up for negotiation is whether these funds are refundable should the Buyer not proceed with exercising its Call Option. As a Call Option Fee can quite often be viewed by Sellers as compensation for the Seller being forced to sell at a price which is locked in, Sellers usually require this amount to be non-refundable so that if the Buyer walks away, the Seller has at least something to show for the inconvenience of entering into an arrangement which ties up the property.

It is however worth noting that Put Option fees may also be payable in the reverse. Given the Buyer may be forced by the Seller to purchase at a particular price, the Buyer may require a certain level of compensation, such as a Put Option Fee.

Finally, Option Fees often incur stamp duty (transfer duty) payable by a certain date. Given there are a plethora of considerations to take into account with Option Fees, it is essential that your lawyer drafts an Option Agreement and gives you advice prior to you signing it. Andrew Pine solicitor can be contacted to draft and advise on Option Agreements.

 

Due Diligence Period

After an Option Agreement is signed up with a Call Option Period (it may even include a Put Option Period), the Buyer may want some further protection – a Due Diligence Period. This gives the Buyer a certain period of time during which it can conduct any investigations of the Property it deems necessary. For example, if the Buyer intends to build a house on the land, a builder may wish to investigate whether one can even be built! The Buyer may also need an Agent to investigate what similar properties in the area are selling for in order to ensure they are buying the Property for a price that works.

In essence, there are an unlimited number of investigations a Buyer can make during a Due Diligence Period. This period usually runs from shortly after the Option Agreement is signed for a fixed number of days by which it is agreed that the Buyer should be able to know enough about the Property to decide whether it wishes to continue with the Option Agreement. If the Buyer does not wish to proceed, it is able to terminate under Due Diligence.

A Primary reason for a Buyer requesting a Due Diligence Period in an Option is where you not only have Call, but where there is also a Put. If an Option Agreement is solely a Call Option, the Buyer could pull out at any time. However, where the agreement is a Put and Call Option Agreement, should the Buyer wish to not exercise their Call, they often cannot terminate, so the Seller may then force the Buyer to buy the Property under the Put Option. Due Diligence is therefore one way the Buyer can terminate should they wish to pull out. Should you wish to discuss any aspect of Due Diligence, Andrew Pine lawyer can advise you on how to protect yourself with drafting an adequate provision in the Option Agreement.

 

The above serves as an introduction to the terminology of Option Fees and Due Diligence. This article does not however substitute for legal advice. It is vital that you obtain legal advice tailored to your circumstances. Andrew Pine solicitor can advise you on Option Agreements with regard to your personal situation.

In our next article we will focus on a Development Approval clause and what is a security deposit. In our fourth article Andrew Pine lawyer will then delve into real-life examples, once the terminology has been explained.

 

Disclaimer: Andrew Pine is a property solicitor practising in Queensland. Andrew is not qualified to give accounting or financial advice. This article is written solely as an opinion of the writer. This article should not be relied upon for legal, accounting or financial advice. You should always seek advice which is tailored to your individual circumstances.

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