Active Option Contract 101
An active option contract is a legally binding document between two parties, an option buyer and an option seller, that outlines the terms related to an option, or property under option, that allows the buyer to exercise a right or not at the election of the buyer within a specified period of time. "Option" means "the right but not the obligation to buy or sell a piece of property within a certain period of time." For the purpose of this article, an active option contract will be referred to as an active option.
An active option creates the right, but not the obligation, to purchase a real estate parcel. Think of it like this—you see something you want at the mall. You think about it for a bit and decide that, if the mood strikes, you can come back and purchase the item, but if, after a couple of weeks thinking about it, you decide that the item may not be what you want anymore , then you can decide not to purchase it. The mall allows this level of flexibility on behalf of the buyer where the buyer can choose to take the item or leave the item once the time period for purchasing has expired.
This is the basic concept of the active option. The buyer gets a right to purchase a property at a specified price within a specified time period at the seller’s request. The seller, in turn, gets paid to grant this right, but has no obligation to sell the property if the buyer chooses not to purchase when the option period expires.
If you want a longer purchase period or if the seller wants a higher price, then you can pay more for the option. This is similar to options traded on the stock market where stocks and shares can be traded very similarly to how real property or real estate can be traded. That being said, the consideration for an active option contract is not based on shares traded on the open market. Rather, the consideration is based on the nature of the underlying property. At the time of execution, that bargain is struck, but, theory would suggest that, since the first option is the cheapest to execute, the amount of the option would go up as the value of the underlying asset increases—and, in this way, it would emulate the stock market.
Active Option Contract Key Features
Active option contracts have several features that differ from other types of agreement and can even affect the very survival of the agreement. Building contracts, for example, do not contain a right of renewal, although there are very clearly defined obligations on the builder to carry out certain works.
One way of defining an active option contract would be "an agreement under which an option is granted and which also imposes further obligations".
The following key features to be found in active option contracts are: Their purpose is to leave the option-holder free to decide whether or not to exercise the option without actively being engaged in negotiation with the option-granter. A party may be unwilling to commit time, effort or money to the transaction which is the subject of an option if the time taken to negotiate the fulfilment of a condition before an option is exercised could be manipulated by the other party so as to frustrate the grant of the option. For example, if the decision whether or not to exercise an option was subject to any other party’s satisfaction with the state of affairs, that party could use its ability to drag the process out to frustrate the option.
Such agreements list the circumstances which must arise before the option can be exercised. Some such circumstances are beyond the control of the option-holder and are therefore satisfactory evidence of a serious intention to exercise the option without the option-holder having to actively engage in negotiation. Such circumstances may include obtaining planning permission, the availability of funds or the completion of due diligence. These are all circumstances which it will take time to check or investigate and cannot easily be manipulated by the option-granter.
There are three key areas to consider when drafting the duration of an active option contract: The term should not be so long that an extension is needed, but at the same time, it should be long enough to allow for the proper investigation by the option-holder of the subject-matter of the option.
The duration of an option is a crucial factor. If it is within the parties’ power to extend the term, the duration may be agreed in principle with the extended term written into the agreement. Strictly speaking, however, it is not necessary for this to be done. If an extension is granted by agreement between the parties, the contract conditions and obligations remain effective. The real problem is the difficulty in proving otherwise.
If no extension is available, the loss of the right to exercise the option is a serious matter. Even longer options are sometimes worthless if they fail to take appropriate account of restrictions on the ability of the option-holder to act on its own initiative. The best possible chance of success in negotiations to extend a contract lies in the period of the option being equal to the total of the terms for satisfaction of those conditions.
The correct answer to the question, "what is a good active option contract" is that it maintains flexibility for the option-holder while at the same time putting sufficient commitment upon him to demonstrate that he may properly be interested in exercising the option.
Active Option Contract Buyer and Seller Roles
An "active" option contract as I just defined it, impacts the responsibilities and rights of the buyer and seller. For a seller, the impact is primarily economic. A seller who has a 10-year active option contract has five years to complete a sale of the property, so obviously the seller can not wait around for that contract to expire. The seller will want to sell the property as soon as possible for the highest price possible, but within the terms of the contract. When working with a seller, I usually work on two tracks simultaneously to test the market. On one hand I work with a buyer looking for the property, and on the other hand I work with the seller to market the property. I am careful to try to balance having my seller receive the maximum price for the property with complying with the terms of the active option contract. For example, if I have a buyer seriously interested in the property, I approach the buyer and ask them to remove any contingencies and pay the deposit now instead of waiting. The buyer will likely turn down that offer, due to the uncertainty that comes with an active option contract.
Buyers have a more difficult relationship with the active option contract. The buyer usually wants to move ahead with the transaction, but is at the mercy of the seller who is trying to receive the maximum price for their property. To complicate matters, the seller may have no motivation to show the property due to the option contract. One way a buyer can deal with this situation is to pay a higher option price at the onset, so that the option price is considered non-refundable at the time of the sale. This higher price can incentivize the seller to move ahead with the transaction in a timely manner or to show the property to potential buyers who could buy the property before the option period is over. As with most real estate negotiations, it is possible for the buyer and seller to agree to terms accommodating both parties. However, when considering this option, a buyer should weigh the advantage of a lower option price against the disadvantage of potentially losing the property to another buyer.
Active Option Contract Benefits
Active option contracts are part of a strategic and carefully constructed framework intended to help buyers and sellers get the most out of their transactions. Aside from the fact that a buyer can obtain real value through an active option contract, having this tool linked to a purchase and sale agreement makes its use easier.
Buyers like active option contracts as a way of establishing control over the subject property. Because the seller knows that the buyer has 120 days (or more if negotiated as part of the agreement) to decide whether or not to proceed with the transaction, that buyer may have more negotiating leverage with the seller, and will probably have an easier time securing financing for the purchase of the property. Finally , an active option contract requires the buyer to make a deposit, which a seller is likely to retain if the buyer backs out of the transaction without the ability to secure financing.
For the seller, an active option contract gives the seller greater assurance that the deal will proceed if the buyer’s financing requirements are met, since the buyer is committed to the contract and more of the purchase price will be secured through a nonrefundable deposit. A seller’s nonrefundable deposit becomes a powerful negotiating tool, especially with respect to any potential alternatives to the proposed sale. If the traditional alternative to a proposed sale transaction is neighbouring commercial developments, the seller will have less trouble giving the buyer time to secure financing.
Active Option Contract Risks and Considerations
The use of an active option contract can pose certain risks and considerations that are important for the parties to keep in mind. For example, the parties may consider whether the continuation of such a contract effectively constitutes a new agreement by the party with the option to renew, and whether this creates a new, legally binding obligation under a theory of equitable estoppel or otherwise.
Some of these potential risks and considerations, and ways to mitigate them, include:
• Construction of an option contract as a unilateral offer that need not be accepted by the other party. It has been said that when the parties do not intend for an option to be a binding contractual obligation, but only an offer that the other party can take or leave, without it giving rise to any liability of the party that has the option to renew, the agreement must be clearly written to reflect this intention.
• Waiver or modification of option contract by an act or course of conduct on part of the owner thereof that foreshadows a waiver of the right of renewal. If clear and convincing evidence shows unequivocally that the options have been waived so that the party with the renewal or extension right has no further claim thereon, the option contract could be modified or waived. A simple conversation between the parties, or conduct of the owner of the renewal right that is inconsistent with any intent to exercise the right, for example, may be sufficient to constitute a waiver of the option.
• An unexercised option that does not contain a specific exercise deadline may nevertheless be unenforceable under any various reasonable notice requirements (i.e., the party with the right of renewal must exercise its right within a reasonable time). This type of notice requirement can be problematic when the option is exercised but the other party, prior to the expiration of a renewal term, decides not to renew the option for any reason. However, the reasonable notice requirement can be satisfied if the party serving the notice informs the other party that it would have exercised its right to extend the option if it had not already done so and if it were not anticipating doing so.
• Possibility that an option contract can be enforced after its expiration. Thus, if the party with the option has adequately manifested an intent to exercise it, it could be enforced after its expiration.
• Extent of damages recoverable for breach of an option contract. This consideration limits recovery often to consequential damages when the failed to perform under an otherwise valid and legally enforceable option contract. Parties can contract around this limitation by specifically addressing the damages available in the event of such a breach.
Active Option Contract FAQs
Active option contracts are common in real estate. Buyers want the ability to get out of a contract if the time comes for them to do so. And sellers don’t want to be wondering, months down the line, whether the buyer is serious about closing.
An active option is an agreement between the buyer and the seller. An agreement that gives buyers the right to opt out of the contract if they need to.
But how does it work? Let’s walk through some FAQs you may have.
How long does an active option last? Generally no shorter than 30 days, but it can be longer. It all depends on how long the buyer wants to keep the option open and how long the seller is willing to have them do that.
Can you sell an active option to someone else? Generally no. The buyer can usually only exercise the option to purchase the property under the terms in the agreement.
How much does an active option cost? Usually, there’s no charge. But sometimes it costs a couple hundred dollars or half of a percent of the sale price . That will depend on the buyers.
Can I sell my house without hiring a real estate agent? Yes. There are many ways to sell a house on your own, especially with a popular tool like an active option contract.
How does an active option contract differ from a regular contract to sell a property? A regular contract for sale has specific conditions for it to be legally binding. A buyer must agree to all of the conditions in the contract for it to be legally binding. However, an active option contract contains specific conditions that need to be met in order for the contract to end and the buyer no longer have any obligations. That does not mean the buyer has to back out or even wants to.
Is there an exception to the real estate rule that says that no contract can be less than a year? Yes, but only if the seller waives their right to that. If a buyer is interested in an active option contract that will be a year or less, they need to review the document carefully to understand the ramifications that the seller has waived.