The golden rules of negotiating option agreements

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Option agreements are a great way for landowners to reduce risk when a third party is interested in buying some of their land for development. However, poorly worded agreements can be costly. Rural property adviser Julie Liddle offers her top tips for getting it right.

What are option agreements? Back to basics

Put simply, an option agreement, when used for development, is a way for landowners to realise an increase in land value without footing the substantial cost of obtaining planning permission. That risk is taken by a developer who, if successful, enables both parties to receive a percentage of the enhanced market value. The percentage each receives is a point for negotiation at the outset.

Option agreements have been successfully used by many farmers and landowners when working with developers seeking planning consent for residential development or renewable energy projects.

Other advantages for landowners and developers

As the landowner, you can take advantage of the skills, knowledge and funds of an experienced developer. As most options are ‘take’ options, unless there is a severe downturn in the market, or conditions attached by the planners to a successful consent are too onerous for the developer to proceed, you are assured of an interested buyer at some point in the future.

You’ll normally receive a non-refundable deposit at the commencement of the option but this is not always the case. This should not be a deal breaker as it will depend on circumstances. If the developer is successful in getting planning permission for the land but does not proceed with the option to purchase, you’ll still be left with land that holds the benefit of planning permission, as well as receiving the deposit.

Securing an option agreement also reduces risk for the developer. If obtaining planning permission takes longer than expected, the developer can be confident they have a legally binding agreement that prevents you getting frustrated and changing your mind about the whole matter.

Avoiding the potential pitfalls

Landowners often confuse option agreements with pre-emption agreements. The latter simply give the prospective buyer the right of first refusal if the vendor decides to sell, whereas an option agreement is a legally binding contract. In other words, if you succeed in completing the event on which the execution of the option depends, for example gaining planning consent, you will have to sell your land, even if other circumstances have changed. This is why good drafting is so important.

There are many pitfalls associated with badly drafted option agreements and below are just some of the areas you need to be aware of.

Duration: A typical option agreement is for three to five years, though this can be longer or extended if a developer’s planning application is ongoing. Therefore, you should consider how a protracted planning process may affect your plans for the farm and whether you’ll be entitled to additional payments if it takes longer than expected. A timetable of the developer’s obligations should be included so that both parties are clear what is expected and by when.

Purchase price: To avoid surprises, be certain as to how the purchase price is calculated and whether deductions apply for unusable parts of the land, or do these parts ‘enable’ the remaining development? You will also want provision in the agreement to ensure the scheme only goes ahead if a minimum land take or a minimum sale price is achieved.

Impact on unpurchased land: Sometimes a developer will want to buy the land in several stages (tranche development). You must therefore ensure the option agreement gives you the right to use the land as freely as possible while planning is sought and obtained. A tranche purchase can make a huge difference to when sale proceeds are received, so this will need to be made clear in the contract.

Third party interests over land: Consultation with other third parties may be needed before an option agreement can proceed. For example, are any areas of the land subject to wayleave? Will you have access to services once the sale of the land is completed? Have you consulted with your bank or whomever has a first charge over the property?

Tax planning: Your accountants and other professional advisers need to be involved at an early stage to ensure you aren’t left with unforeseen charges or tax penalties. The agreement needs to protect your right as the landowner to suspend or delay exercise of the option if there is a substantial or adverse change in the tax regime.

Decommissioning: If your option agreement is for a renewable energy scheme you will need to agree a decommissioning period. Will that be included in the agreement and who is paying?

Future increases in value (Overage): You will want to ensure the value of the land is not increased after it is bought from you, such as by a new planning permission being obtained, without receiving your share of that subsequent increase.

Walk away: How easily you can end the agreement if the developer doesn’t conform to the contract provisions? Conditions on which the parties involved can walk away from the agreement need to be made clear.

Seeking professional advice

There are many more matters to consider than those listed above. Don’t expect all your concerns to be picked up when the option is being drafted. By then it may be too late. Matters like overage, for example, are incredibly complex and need to be dealt with by an expert. With accurate drafting, option agreements and can provide both developers and landowners with security no matter how unpredictable the future.

For advice on any rural land and property issues, call Julie on 01768 254 354.