There is no doubt, the property market has slowed. As investors and developers alike reposition themselves for the new market conditions, we are seeing increasing numbers eager to find a way out of the option agreements entered into at the height of the market.
In this article we take a look at what can happen to option agreements in a softening property market and also analyse some unusual legislative requirements that can allow a party to walk away from the deal – which could potentially spell disaster for a vendor.
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Options – A brief explanation
There are two types of options commonly used to transact property:
A call option and put option will frequently be used in the same transaction document in the sale and purchase of a development site. The benefits of doing this include the ability to delay payment of the duty on the contract for sale and, in limited circumstances, the nomination of a third party to purchase the property.
Is it “residential property”?
The Conveyancing Act 1919 (NSW) (Act) contains a number of provisions that regulate options for the sale of residential property. The Act defines “residential property” as:
but does not include:
Given the above, it is not uncommon for a development site to meet the definition of residential property, especially in circumstances where the property being sold is vacant, the zoning of the land does not prohibit residential accommodation and the area of the land 2.5 hectares or less.
Options to purchase residential land
If the land being purchased under an option agreement is for the purchase of residential property then, under the Act, it:
The option will be void if it does not comply with these two requirements. We are seeing examples of parties failing comply with the exchange by counterparts requirements.
Example: ABC Pty Ltd wishes to enter into a call option agreement with BPC Pty Ltd, the owner of a 2ha vacant residential land in Rouse Hill for $7 million. The purchaser pays a 10 per cent deposit. The parties sign the same copy of the agreement instead of each signing a counterpart of the agreement. Consequentially, the option agreement is void and the purchaser is entitled to receive a refund its deposit.
Prescribed Documents and the proposed contract for sale
Another problem area affecting the purchase of residential property is the failure by the party preparing the option agreement to attach to the agreement complete copies of the vendor disclosure documentation. Under the Act, the option agreement must have attached to it:
Failure to attach the above documents gives either party the time-limited right to rescind the option agreement or, if the option has been exercised, the contract for sale.
Example: ABC Pty Ltd wishes to enter into a call option agreement with BPC Pty Ltd, the owner of a 2ha vacant residential land in Rouse Hill for $7 million. The purchaser pays a 10 per cent deposit. ABC Pty Ltd prepares the option agreement and is unware of the requirement to attach a copy of the proposed contract for sale to the agreement. The parties sign counterpart agreement that do not contain copies of the contract. At a later point, ABC Pty Ltd releases that it deal is not commercially viable and, upon receiving legal advice, exercises its right to rescind the agreement and receive a refund of its deposit.
Interestingly, the Act allows either party the right to rescind.
The decision of Sieve-Storm Pty Ltd ACN 160 562 354 as trustee for Affordable Property Trust v Murphy  NSWSC 1800 (Murphy Decision) considered the relevant sections of the Act and whether it was equitable to allow a vendor, who had prepared the option agreement in that case, the right to rescind the agreement in circumstances where it was not correctly prepared.
The Murphy Decision focused on the enforceability of two call options granted by the defendant (Murphy) to the plaintiff (Sieve-Storm). The call options related to:
Sieve-Storm and Murphy entered both the First Option and the Second Option in 2013. Sieve-Storm provided $1 as consideration for the call options being granted.
In 2016, Murphy realised that:
Murphy decided to rescind the First Option and Second Option. The NSW Supreme Court was required to consider whether it was equitable for Murphy to rescind the option agreements. In that decision the Court determined that:
The Murphy Decision is important as it established that either the vendor or the purchaser can exercise a right to rescind under the Act regardless of who prepared the agreement. This outcome might be different if a significant option fee has been paid and the party challenging the rescission seeks to rely on equitable remedies on the basis that the other party prepared the deficient agreement.
The laws governing options is complex. A poorly drafted option agreement can inadvertently allow one or both parties a right to walk away from the transaction. Parties that wish to use option agreements should ensure that their legal representatives are experienced in the drafting and advising on these types of agreements.
Parties who have entered into option agreements at the height of the property market that are still in force today, may be concerned, or interested, in whether those agreements are binding. In particular, developer purchasers who entered into option agreements before the softening of the market may now be interested in finding ways out of agreements that no longer provide good commercial outcomes for their business.
Vanya Lozzi, Partner
T: +61 2 8083 0462
Richard Skopal, Partner
T: +61 3 9321 9866
Katie Miller, Partner
T: +61 7 3135 0606
The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this newsletter is accurate at the date it is received or that it will continue to be accurate in the future.