Land purchasing: agreement terms

Protecting your options

25 January 2016

Agreement terms should be carefully considered when taking options on land acquisition, cautions Kirsten Dunlop

Options to purchase land are a good means of securing rights to buy, without commitment. They can be simple or complicated. An option must be in writing and can be a deed or an agreement, provided that payment of an option fee is included.The advantage of an option rather than a conditional contract is that there is no obligation on the purchaser to exercise the option.

Options can be exercisable on a fixed date, but more usually during an agreed period triggered by a particular event. This is commonly the grant of a satisfactory planning consent after all reserved matters have been dealt with. The option period needs to be long enough to allow the developer sufficient time to carry out all necessary due diligence, which may include searches and surveys, environmental tests, finalising layout plans, and obtaining planning and other consents.

From a developer’s perspective, the period should be capable of being extended on more than one occasion. At a minimum, this should be at expiry, if a planning decision is outstanding, if other key consents remain, or if a challenge to planning or judicial review is in progress. The time for serving the option notice should not end until after the last appeal or judicial review has been decided.

Options are often used where a developer wants to acquire adjoining land to form one large site. It may suit to take the whole of a landowner’s title, provided the developer can elect later to acquire only the proportion necessary for the development. While this will mean paying a higher initial option fee, the purchase price will ultimately reflect the extent of land actually acquired, which gives the developer maximum flexibility.

Restrictive planning

Where the trigger event is the grant of a satisfactory planning consent, the developer can conclude its plans and due diligence before exercising the option. However, the agreement should also allow the developer flexibility to purchase without waiting for planning approval.This may be important if, for example, a rival developer becomes interested in the area, where the land includes a useful ransom strip or if there is a fixed longstop date that cannot be further extended.

An option to purchase that is exercisable on the grant of a specified planning consent should be avoided because it is too restrictive and could become worthless if plans for the site have to change following due diligence or required by the planning authority.

It is crucial to ensure that the valuation method is clearly set out in the option agreement

Landowners may want to include a longstop date to give certainty over when they will receive the purchase monies. They will also want to ensure that the developer cannot exercise the option to purchase a large area of land but then only build a small development in the first instance, with the intention of avoiding overage payments and then later extending the development.

For this reason, the landowner may include a minimum planning description to confirm the size and/or composition of the development (e.g. primarily residential comprising not less than 40, two-bed units with retail/commercial elements).

Inclusion of a longstop date and a minimum planning description can be acceptable to a developer provided that satisfactory planning consent is defined from its own perspective and not objectively.

Purchase price

The option agreement will refer to a fixed purchase price or include a method for establishing the open market value of the land at a specific time (usually once satisfactory planning consent has been obtained). The price will be a percentage of that figure, less specified developer’s costs. It is common for the agreed purchase price to be stated in the notice, so it is crucial that the valuation method is clearly set out in the option agreement, including the assumptions and disregards.

Flawed valuation provisions may lead to landowners having to accept much lower purchase prices than they anticipated, or, for developers, can result in an unacceptable land value that renders the development unworkable. The option agreement should, therefore, include provisions setting out how disputes, as to value or validity, will be resolved.

Serving the notice

The option notice must be drafted strictly in accordance with the terms of the agreement to avoid any argument as to invalid service. It is important, therefore, that the agreement is clear on its requirements. For example, it should not state that the deposit monies be paid on the same day as the notice is served, because if the bank transfer fails, the option will be invalid.

Overage

If land will only achieve its maximum potential value following a certain event (such as grant of planning), the landowner will want to include overage provisions in the agreement to ensure they get a share of the increased value at that later date.

An example would be where the agreed purchase price is reduced to factor in the developer’s additional costs for remediating polluted land. The option agreement can include provisions requiring a final accounting of the costs and profits, so that if the eventual value is higher than the baseline value, the landowner will receive an additional payment at practical completion, or at a specified time after that date.

Rights to overage can be secured by imposing a charge, guarantee or bond, or registering a positive or restrictive covenant on the land. An alternative is for the landowner to be granted a reverse option, giving it a right to buy back the land if the developer fails to pay the overage when due.

Protecting the option

If land is registered, the option should be an agreed or unilateral notice and a restriction entered on the title at the Land Registry. For unregistered land, the option agreement should be registered as a class (iv) land charge at the Land Charges Register. Failure to do so means a third party could acquire the land free of the option.

Stamp duty land tax

SDLT may be payable on the grant of an option depending on the amount of the fee. If the agreement contains reference to future unascertainable overage payments then SDLT is payable on an estimated purchase price, adjusted if the final agreed price is higher or lower. Alternatively, a developer can apply to defer payment of SDLT if the final figure will not be known for at least six months. Land options will continue to be a useful tool for strategic acquisitions provided the proper advice is taken and the agreement terms ensure the developer does not waste both time and money.

Kirsten Dunlop is a Senior Associate in the real estate team at law firm Winckworth Sherwood

Further information

Download a complete “Land purchasing: agreement terms” PDF