We see option contracts for real estate purchases frequently, and we run into problems with those contracts just as frequently. In this blog we’ll go over what option contracts are, what they require to be effective, and we’ll identify some common pitfalls.
An option contract is a promise by the owner of property to sell it to a buyer for a specified price, but only if the buyer chooses to buy it. In that sense, it is a one-way street – only the owner of property is bound to do anything under the contract, and the buyer is not required to purchase the property. Owners like option contracts because they are typically paid a fee for giving the potential buyer the right to purchase the property, and because they know that they have a potential buyer that is much more invested in the property than a “tire kicker” would be. Buyers like option contracts because they are low-risk, they lock in the purchase price for a stated period of time (whether it goes up or down), and they give the buyer plenty of time to get their ducks in a row prior to pulling the trigger on an enforceable purchase contract (financing, due diligence, other pending deals, etc).
Option contracts require that the buyer give some “consideration” for the right that is granted to them – typically this takes the form of a payment of money to the owner. If the buyer conveys no consideration to the owner, than a binding option contract doesn’t exist – instead, the owner has merely made an offer to the buyer to sell the property for a stated price, and that offer can be rescinded at any time. Like any other contract dealing with real estate, option contracts have to be in writing to be enforceable. They should clearly state the period that the option will remain open, and clearly state the manner in which the option can be exercised.
The option that is granted to the potential buyer is only left open for a stated period of time, and after that period passes the option evaporates. If the buyer does exercise the option during its effective life, then the option is converted into a contract which is binding between both the buyer and seller to purchase and sell the property. So an exercised option really involves two contracts, the first being the option contract and the second being the purchase and sale contract.
Seems pretty straight-forward so far, right? But most people reading this blog are aware that the second type of contract listed above (the Purchase and Sale contract) has plenty of terms that are typically negotiated between the parties. If those terms are not negotiated at the time that the option contract is put in place – so that the parties understand what terms will exist in the final purchase and sale contract if the buyer decides to exercise the option – then they have set themselves up for future disputes. For instance, how long after the exercise of the option until closing? Will the buyer be permitted to obtain financing? What inspection rights or remedies will there be? Will the contract be assignable? For that matter, will the option be assignable (unless the option specifies “no,” the default will be “yes”). Who is paying for what closing costs and who will be closing the deal? All of the nitty-gritty details that typically go into the negotiation of a purchase contract represent potential future conflicts between the buyer and seller if they are not agreed upon at the same time as the option is agreed on.
Sellers and buyers are encouraged to think through these issues beforehand, and to memorialize their agreement in the original option contract. An alternative is to attach to the option contract, the form of purchase contract that will eventually be used by the parties, executed by the Seller and with all material terms filled in. The buyer can then trigger the option by executing that document and delivering it to the seller during the option period. Regardless of how the details of the sales transaction are agreed upon, they need to be dealt with up front, or the parties risk the unsavory prospect of letting a judge decide what terms do or don’t exist down the road (hint: lacking a writing setting out terms, a judge is not going to write new terms; instead they will likely leave the parties with only the terms specifically agreed on: that the buyer is obligated to buy the property from the seller for the agreed price within a reasonable period of time – any other terms need to be contractually defined).
As always, should you have any question please contact your local real estate attorney. In the meantime, happy optioning!
Berlin Patten Ebling, PLLC
Article Authored by Daniel C. Guarnieri, Esq. firstname.lastname@example.org
This communication is not intended to establish an attorney client relationship, and to the extent anything contained herein could be construed as legal advice or guidance, you are strongly encouraged to consult with your own attorney before relying upon any information contained herein.
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