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What you need to know in a softening property market

14 November 2018

#Property & Real Estate

What you need to know in a softening property market

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. 

We will hold a panel discussion on November 28 looking at how to make the most of current market conditions. Click here for more information.  

Options – A brief explanation

There are two types of options commonly used to transact property: 

  • a “call” option, under which the property owner grants a prospective purchaser the right to purchase the property, for an agreed price, with the right exercisable within a fixed period of time
  • a “put” option, under which a prospective purchaser grants the property owner the right to require the purchaser to buy the property for an agreed price, with the right exercisable within a fixed period of time.

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: 

  • land on which there is situated (or in the course of construction) not more than two places of residence, and no other improvements
  • vacant land on which the construction of a single place of residence alone is not prohibited by law
  • a lot or lots (including a proposed lot or lots) under the Strata Schemes Development Act 2015 (NSW), comprising not more than one place of residence alone, whether constructed or in the course of construction, and including any place used or designed for use for a purpose ancillary to the place of residence

but does not include:

  • land or a lot that is used wholly for non-residential purposes
  • land that is more than 2.5 hectares in area.

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

Counterparts

If the land being purchased under an option agreement is for the purchase of residential property then, under the Act, it: 

  • must be granted by way of an exchange of counterparts, one of which is signed by the purchaser and the other signed by the vendor
  • cannot be exercised within 42 days after it is granted. 

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:

  • a copy of the proposed contract for the sale of the property that includes the “particulars of the purchase price”
  • the documents prescribed under the Conveyancing (Sale of Land) Regulations 2017 (NSW) (Prescribed Documents).

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 [2016] 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:

  • a property located at 45 Robertson Road, Killarney Vale, New South Wales (First Option
  • a property located at 12 Gillies Street, Kurri Kurri, New South Wales (Second Option). 

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:

  • the First Option did not have attached to it the proposed contract for sale or the Prescribed Documents 
  • the Second Option had attach these documents, but the proposed contract for sale did not include the “particulars of the purchase price”.

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:

  • either the Grantor or the Grantee could exercise a right to rescind where the required documents were not attached to the option agreement 
  • given the above, that Murphy had validly rescinded both the First Option and the Second Option
  • because of the limited option fee paid by Sieve-Storm and the conduct of the parties, Sieve-Storm could not establish an argument of estoppel. 

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.

Conclusion

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.

Authors: Vanya Lozzi & Elly Ashley

Contacts:

Sydney
Vanya Lozzi, Partner
T: +61 2 8083 0462
E: vanya.lozzi@holdingredlich.com

Melbourne
Richard Skopal, Partner 
T: +61 3 9321 9866
E: richard.skopal@holdingredlich.com

Brisbane
Katie Miller, Partner
T: +61 7 3135 0606
E: katie.miller@holdingredlich.com

Disclaimer
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.

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