Developers often use ‘put and call options’ when buying residential lots as an alternative to traditional contracts with long-dated settlements. The motivation for them doing this is usually just to defer payment of stamp duty while they progress their development application.
However there are risks for vendors that you need to be aware of.
What are Put & Call Options
A ‘put and call option’ is a contractual right granted under an agreement conferring:
• To the buyer, a future right to compel a vendor to sell land (the “call option“)
• To the vendor, a future right to compel the buyer to buy land (the “put option“).
The respective options will state a purchase price (sometimes referred to as the ‘strike’ price) as well as time periods in which the option must be exercised.
There is a non-refundable option fee payable when entering into the agreement. Whereas the call option fee is normally 5% – 10% of the purchase price, the put option fee is usually nominal (e.g. $1).
With the combination of both the put and call option, it is possible to achieve the same legal commitment to purchase and sell a property as a standard contract for sale.
However, because stamp duty is only payable after exchange of contracts, the granting of options does not itself trigger an obligation to pay stamp duty. Instead, the stamp duty is delayed until the options are exercised and contracts exchanged.
Here’s 6 things to look out for your vendor clients:
1. Don’t forget the put option!
Developers will sometimes try and negotiate just a call option. While they may offer an enticing ‘strike price’ and probably also a large non-refundable option fee, vendors need to be aware that a call option without a corresponding put option leaves all the optionality with the developer.
So while a vendor will be prevented from dealing with their property during the option period (sometimes as long as 18 – 24 months), the developer is completely at liberty to walk away at the end if there is no put option in place. The vendor’s lawyer needs to make sure the strike price and exercise periods on the put match the call option.
2. Cooling off periods still apply – get a 66ZF certificate!
Some people will probably be aware that there is no cooling off period if a contract for sale of land is made in consequence of an option to purchase the property.
However, there is a cooling off period that applies to the option itself. Like the cooling off period for a conventional sale contract, this can be waived by a buyer’s solicitor but the relevant certificate that needs to be provided is a called a 66ZF Certificate (not a 66W Certificate).
3. Attach contract for sale of land to agreement
The law requires that in order for a legal agreement to be valid, its terms must be certain – and this principle applies to option agreements. It is usually not sufficient for a put & call option to simply say that when the option is exercised, the parties will enter into ‘a’ contract for sale.
That eventual contract for sale could potentially contain terms which one of the parties did not contemplate from the outset or may disclose matters the purchaser wasn’t aware of.
The better practice is to actually attach a draft contract for sale to the option agreement as a schedule along with all the usual disclosures. The option agreement would then refer to the scheduled contract as being substantially the form of contract the parties will enter into. It’s probably also worth having the purchaser pre-sign the contract for sale of land to be held by the agent in escrow, if that’s possible.
4. Make sure there are director guarantees provided
Residential property developers take on more risk than the average buyer in the market as they look to maximise returns and vendor’s need to be aware that developers do often default.
It is common practice for them to structure their property holdings through companies. However, if the developer gets into financial trouble, vendors don’t want to be in a situation where they are looking to exercise their put option against an insolvent company. For that reason, it is imperative that the option agreement contains a director’s personal guarantee to perform the obligations of the company (i.e. the put) if the company fails to do so.
5. Maximise call option fee
In a similar vein, because of the typically greater counterparty risk on put-call options, the vendor should try and negotiate as large an upfront option fee as possible. Anything less than five per cent should really be rejected while a ten per cent fee is the goal. That way, if the developer is not able to complete the transaction, the vendor is not left (as badly) out of pocket.
If the developer cannot pay the full ten per cent upon the granting of the option, it should be required to top-up that amount during the option period.
6. Vendor should get tax advice
On the topic of option fees, vendors should talk to their accountants. Even though, substantively, these fees are like conventional ‘deposits’ on property transactions, accountants sometimes regard them as revenue separate from the property transaction. This can mean, among other things, that vendors aren’t entitled to the full capital gains tax exemptions that they would normally receive when selling their principal place of residence.
It is normally possible to structure around this situation once an accountant’s advice is obtained.
If you wish to discuss any of the above with one of our lawyers, please don’t hesitate to get in contact with us on (02) 8315 3118.