Conditional Contracts and Option Agreements
What is a conditional contract?
A conditional contract is a contract which specifies that certain conditions must be met as a pre-requisite to the sale going ahead, usually the grant of planning permission in a form that is satisfactory to the developer. Once the conditions have been met in accordance with the contract, then the contract becomes unconditional which in turn triggers completion of the sale of the property.
Whilst a contract conditional on planning permission is the type of contract which is most often encountered, a contract can be conditional on many other factors, such as the grant of additional licences, the availability of funding, the completion of highways or infrastructure works or any dwellings being constructed to golden brick stage.
What is an option agreement?
An option agreement is a contract entered into between a landowner and a developer for a specified period of time. Unlike a conditional contract, there is no commitment from the developer to purchase the land and the developer usually has discretion whether to call upon the option. If the developer calls upon the option, the landowner is obliged to sell the property in accordance with the terms of the option agreement.
How long does an option agreement last?
Typically option agreements can last anywhere from 6 months to ten years, but the norm is usually around 5 years.
The length of the option will depend on the site in question and how quickly planning permission may be secured on the site. If the site requires allocation, for example, then a longer term option will be required.
Further, option agreements usually include extension provisions to allow the developer to extend the option in certain circumstances, such as in the event that a planning application has been submitted but not yet determined.
Why choose a conditional contract?
A conditional contract will usually be the preferred choice of contract for a landowner as there is a binding commitment for the sale and purchase of the property, provided the various conditions are satisfied.
Conditional contracts may also be preferable for more immediate developments, where a developer is happy to obtain planning permission and proceed to completion without delay and there is a good chance that planning permission will be granted.
Are there any downsides to a conditional contract?
If a conditional contract is entered into it is crucial that the conditions are worded extremely clearly and unambiguously to ensure there is not a dispute as to whether the condition has been fulfilled later down the line. For this reason, the drafting of conditional contracts can be extremely complicated and subject to considerable negotiation and so they are usually more costly and time consuming to agree.
Developers will also try to add a discretionary or subjective element to the conditions, to allow the ability to terminate the contract in the event the planning consent is not satisfactory or for other commercial reasons, which could have the effect of turning the conditional contract into an option. This will therefore be unsatisfactory for many landowners and many landowners will often find themselves in a position where a developer seeks to terminate the contract and renegotiate the deal on the basis that the conditions have not been satisfied.
What are the advantages of opting for an option agreement?
An option agreement is often more favourable for a developer than an option agreement for the following reasons:
- There is no commitment to purchase the land and so the developer can “bank” the land for a specified period of time which allows the developer to hold numerous properties for strategic purposes and develop them as and when it sees fit.
- If there is a concern that a developer may not be able to secure a satisfactory planning permission, then an option would be more favourable as it avoids the argument of whether a satisfactory planning permission has been granted, and the conditions satisfied.
- The site may not have an immediate chance of securing planning permission and so a developer can enter into a longer term option agreement and attempt to allocate the land for development.
- If there are concerns that third parties may become difficult and raise planning objections or other claims, such as an argument that there is a public or private right or way or a town and village green, then an option would be preferable so the developer has absolute discretion whether to proceed with the purchase.
- A nominal sum is often paid to enter into the option, as opposed to a conditional contract where a 10% deposit is usually required.
- The developer has certainty that the site cannot be sold to any third party during the option period.
- If a developer is assembling sites under different ownerships, then an option gives a developer the flexibility to do this and to only exercise the option if all of the proposed land can be assembled.
- If there is reduction in purchase prices, then the developer can walk away or renegotiate the deal.
Given that the benefits for the developer are extensive, should a landowner be put off by an option agreement?
Whilst an option agreement is entirely that, an option, more often than not an option agreement will be exercised provided that planning permission is obtained. This is due to the fact that a developer will incur substantial costs in its searches and investigations, planning costs and legal fees and accordingly they are unlikely to not exercise the option agreement unless there is a real commercial reason to do so, such as a fall in the market.
Further, like conditional planning contracts, there are usually provisions requiring the developer to apply for planning permission during the option period. This then provides the landowner with comfort that even if the option is not exercised but planning permission is granted, then the land will revert back to the landowner with the benefit of planning permission and the landowner can sell the land to a third party. The landowner will then own a site with planning permission which it has not had to pay for and the site will arguably be more valuable to the landowner.
Any further questions?
If so, please contact a member of our planning and development team as we have extensive experience in acting for both landowners and developers in drafting and negotiating option agreement and conditional contracts and would be happy to answer any questions which you may have.
This article is for general guidance only. It provides useful information in a concise form. Action should not be taken without obtaining specific legal advice.