Owen Walsh, Commercial Property Partner
Option agreements provide tremendous advantages for developers and landowners. Overage for landowners can sweeten a deal considerably. However, as a legally binding contract, an Option Agreement should be given careful consideration from both parties. Furthermore, meticulous drafting is required to ensure the benefits and objectives of the developer and landowner will be met and there are no nasty surprises when overage payments are calculated.
What is an Option Agreement?
An Option Agreement grants a developer the right to purchase land following a trigger event, in exchange for a non-refundable deposit to the landowner. The trigger event is usually the grant of planning permission. The option must be exercised within an agreed time period. If the developer fails to purchase the land within that time, the option will lapse and the landowner will keep the deposit.
There are four types of Option Agreements:
- Call option – whereby a developer has the right, but is not obliged, to require the owner of the property to sell the land subject to the option. These are the most common type of Option Agreements.
- Put option – where the landowner has the right, but no obligation, to require the developer to buy the property.
- Cross option – the developer receives a call option and the landowner, in return, gains a put option.
- Reverse option – occasionally, this type of option is used to secure an overage payment (see below). The landowner receives an option to purchase the property back after the ‘trigger’ event occurs if the overage payment is not forthcoming. The resale price will reflect the increase in the value of the land because of the ‘trigger’ event (e.g. planning permission being granted).
What are the advantages of a call Option Agreement to the developer?
If a commercial property developer secures an Option Agreement over a desirable piece of land, the advantages include:
- Confidence that the property is secure from being snapped up by a competitor whilst planning permission and/or investment is being sought.
- If planning permission is refused, or only granted under onerous conditions, the developer does not have to exercise the option to purchase.
- The Option Agreement can be registered on the title; therefore, it will bind a third party who buys the land within the option period.
- If plots are being assembled via land purchased off separate landowners, the developer can first ensure it has secured all the required plots before exercising the options.
What is the difference between an Option Agreement and a Pre-emption Agreement?
A Pre-emption Agreement gives a developer (or any other potential buyer) the right of first refusal to buy a particular property, but only if the owner decides to sell it within an agreed period. A call option allows the developer to ‘call’ on the landowner to sell, and the owner is contractually obliged to do so.
What is overage?
A commercial property development can, depending on market conditions at the time of sale, reap considerable financial rewards, far above the expectations of a landowner at the time an Option Agreement was exercised. An Overage Agreement (sometimes known as ‘clawback’) allows the seller to receive additional payments if the land turns out to be more valuable than projected. Overage is usually triggered by the occurrence of an event which increases the value of the land. Common ‘trigger events include:
- the grant or implementation of planning permission
- disposal of the property or part of the property with planning permission
- completion of development
- sale of plots within the completed development
- on-sale of the property within a specified period
Landowners who receive expert legal advice will ensure there are multiple trigger events for overage payments; for example, every time a plot is sold, an overage payment is due once a set threshold is met. Certain sellers, such as public bodies, are legally obliged to transfer property for the best return possible and overage provides a mechanism to achieve this.
Careful drafting is essential when it comes to Overage Agreements. In George Wimpey UK Limited v VI Construction Ltd [2005] EWCA Civ 77, the formula for calculating the overage payment was so complex that one party failed to notice a crucial part of the method was not included in the final contract. The Court of Appeal refused to rectify the document on the grounds of unilateral mistake. And in Barnet London Borough Council v Barnet Football Club Holdings Ltd [2004] EWCA Civ 1191, a legal battle resulted from a simple drafting error over the positioning of brackets in a sentence, which related to a potential development value of over £5 million. Again, the Court of Appeal refused rectification.
In practice, parties to an Overage Agreement often negotiate terms of an overage and its calculations between themselves. However, as the two cases above illustrate, the Court’s willingness to rectify a unilateral mistake in a contract is narrow. It is therefore imperative to have both an Option Agreement and any overage provisions checked by an experienced commercial property solicitor prior to signing.
In summary
Mitigating risk is essential in commercial property development. Understanding the law around Option Agreement and overage helps prevent simple mistakes result in profit and reputational loss.
If you require any advice on option agreements, overage or any other commercial property matters, please get in touch with Owen Walsh, a Partner in our Commercial Property Team
Please note – this article does not constitute legal advice.
