In the ever-rising landscape of property developments, put and call option deeds are a popular mechanism in property transactions.
Property developers often ask vendors to structure a land sale and purchase by way of an option deed in order to:
- allow time to undertake due diligence on the property and its development potential;
- allow time to nominate the appropriate purchaser of the property; and
- delay the payment of stamp duty until the exercise of the option.
However, the law relating to option deeds is complex and recent cases have shown the serious financial consequences which can arise if options are not structured and implemented with full knowledge of the law.
One such case which demonstrates the various risks to vendors entering into put and call options is the recent decision of BP7 Pty Ltd v Gavancorp Pty Ltd [2021] NSWSC 265 (BP7 v Gavancorp).
This article outlines the basic elements of put and call options before ultimately analysing the lessons to be learnt from the BP7 v Gavancorp decision.
What are put and call options?
A 'put and call option' is an agreement between a vendor and purchaser that consists of:
- a call option – giving the purchaser a future right to force the vendor to sell the property; and
- a put option – giving the vendor a future right to force the purchaser to buy the property.
Practically, option deeds are given effect by the following process:
- Offer and acceptance of terms is secured between vendor/grantor and purchaser/grantee
- Option deed (either put, call or put AND call) is drafted – a complete copy of the contract for sale of land that will come into effect on exercise of the option must be annexed to the option deed
- A call option fee, which is normally non-refundable, is payable by the purchaser on exchange of the option deeds
- A put option fee may also be payable by vendor/grantor to the purchaser on exercise of the put option, but it is typically nominal
- The put and/or call options must be exercised by notice in writing within prescribed timeframes (option period) stated within the option deed
- When a party exercises their option under the option deed, the contract for sale of land automatically comes into existence between the parties and there is generally a requirement for contracts to be formally exchanged. If neither party exercises their option, then the option deed is terminated at the expiration of the final option period.
Residential property
An important consideration into whether the findings of BP7 v Gavancorp applies to certain option deeds is whether the deeds concern residential or non-residential properties. The meaning of "residential property" is defined in section 66Q of the Conveyancing Act NSW (Act) as including:
- Land with less than two places of residence situated upon it (or in the process of being constructed) with no other improvements;
- Vacant land on which a single place of residence alone is permitted to be constructed; or
- Lot(s) (including proposed lot(s)) under the Strata Schemes Development Act 2015 comprising not more than one place of residence alone, whether the lots are constructed or in the process of being constructed. Such lots in this category also include spaces used or designed for a purpose "ancillary" to the place of residence, such as common property areas.
But not including:
- Land/lots used entirely for non-residential purposes; or
- Land that is more than 2.5 hectares in area (or other areas as may be prescribed).
The property which was the subject of the option deeds and contracts for sale in BP7 v Gavancorp was residential property within the meaning of section 66Q. The legislation considered by BP7 v Gavancorp (sections 66T and 66U of the Act) concerns cooling off periods in residential property.
BP7 v Gavancorp case – the facts
In the BP7 case, the plaintiff, BP7 was a developer purchaser who entered into deeds of put and call option with the eighteen defendants, who were individual vendors, to purchase residential properties in Cronulla. Under the deeds, the developer purchaser paid each individual vendor a call option fee.
The developer purchaser subsequently chose not to exercise the call options to purchase the properties.
The vendors, wanting to enforce the purchase of the properties by the developer purchaser, then exercised their put options in accordance with their right under the put and call option deed. In accordance with the terms of the deed, a contract was deemed to be entered into between the parties on the date the put options were exercised.
The developer purchaser then proceeded to rescind the contracts pursuant to the cooling off rights granted to the developer purchaser by the deed and under section 66U of the Act. When the vendors did not refund the developer purchaser's call option fees, the developer purchaser sought declaratory relief from the Supreme Court to the effect that:
- The deeds were so rescinded as claimed by the developer purchaser; and
- On the basis that the deeds were rescinded, the developer purchaser was entitled to be refunded for its option fees.
The court found in favour of the developer purchaser as against the vendors.
Issues
Drake J of the Supreme Court had to consider two separate issues:
- Did the developer validly rescind the contracts?
- Is the developer entitled to a refund of the call option fee, which became the deposit payable under each contract?
Issue 1: Were the contracts validly rescinded?
The vendors argued that the developer was not entitled to a cooling off period under section 66U of the Act, as the contracts fall under the exemption in section 66T(d).
The Court had to determine whether the 'option to purchase' in section 66T(d) included put options.
Section 66T(d) states that "There is no cooling off period in relation to a contract for the sale of a residential property if....the contract is made in consequence of the exercise of an option to purchase property..."
The expression 'option to purchase' is not defined in the Act.
Drake J interpreted the ordinary and natural meaning of 'option to purchase' as a choice available to the holder of an option to purchase a property. Call options in their nature are options to purchase. In comparison, put options do not give the option holder the choice to purchase property but gives the holder a choice to sell the property.
On this basis, the Court decided that the exemption under s66T(d) applies to call options, but not put options, and that the developer purchaser was entitled to rescind the contracts under section 66U of the Act.
Issue 2: is the developer entitled to a refund of the call option fee?
In relation to issue 2, the vendors referred to clause 4.2 of the option deed which provides that "if an Option is not exercised ...the Grantor retains the Call Option Fee.." and argued that the call option fee should not be characterised as a deposit but rather a non-refundable fee.
The Court determined that in accordance with the terms of the deed, the call option fee became part of the 'deposit' payable by the developer under the contract for sale when the contracts were formed.
Accordingly, under s66ZE of the Act, as the contracts were validly rescinded, the developer was entitled to a refund of the 'deposit' (being the call option fee) less 0.25% of the respective purchase price, despite the deed stating that the call option fee was non-refundable.
Implications
The findings of BP7 v Gavancorp apply to option deeds for residential land (the case is not applicable to non-residential land). This decision highlights some of the risks involved for vendors entering into non-traditional arrangements for the sale of property, namely conditional option deeds. As there is a risk of purchasers exercising their rights to cool off on a put option, such options no longer provide certainty for vendors, or their financiers.
In order to overcome the dilemma faced by the vendors in BP7 v Gavancorp (in which the developer purchasers obtained a cooling off period in respect of the contract which arose subsequent to the exercise of the put option), vendors need to insist on purchasers providing not only a section 66ZF certificate waiving the cooling off period for the option deed, but also a section 66W certificate waiving the cooling off period for the contract for sale which will arise in future when the put option under the deed is exercised.
Financing development projects is a fundamental commercial consideration for developers. Finance providers in large development projects will typically rely on pre-sales exchanged contracts to determine the available finance and security required.
The decision in BP7 v Gavancorp creates a new door for developer purchasers to escape their obligations under put and call option deeds by enabling developer purchasers to exercise their cooling off rights and rescind the contract for sale, even if they have not exercised their call option and the owner/grantor has exercised the put option. In turn, development funding is made more complicated for developer vendors, especially when finance providers require unconditional or irrevocable agreements with purchasers as a pre-requisite to finance.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
