What is an Option Contract?
Whether you’re in the real estate or legal business, you may find that an option contract will serve a particular purpose for you. But even if you’ve utilized option contracts before, how much do you really know about them?
What Is an Option Contract?
Simply put, an option contract is a contract where the seller grants the buyer the right to buy or sell a particular underlying asset at a predetermined price within a specific period of time. Many different businesses find various uses for option contracts. For example, what are some of the uses for option contracts in the legal business? One example would be where a firm makes an agreement with its landlord to, essentially, "lock-in" a rate for its office lease. This protects the firm from future fluctuations in real estate prices. Some firms reward their employees with option contracts, giving them the right to purchase certain types of stock at a fixed price.
The main areas in which option contracts can be used are broadly in the areas of finance, real estate and employment. In the case of finance, they legally bind buyers and sellers to the minimal benefits of knowing in advance the price of the asset and having a legally binding contract for the buying and selling of the asset. In the case of real estate , it can be a contract to purchase or lease the property. For employment, it can be a contract to purchase a company stock (if it is publicly held) or a contract where the employee is granted a profit share (equity options) and the option gives the person the right to sell their shares or the option itself (as a contract).
But who are the parties involved in an option contract? There are generally two parties involved: a buyer and a seller. In business, the term "grantor," is more commonly used rather than seller. The terms of the agreement are defined by the purchase agreement.
Basic Elements for an Option Contract
Regardless of the type of your option contract, there are basic elements within the contract that can be changed, such as: The elements of an option contract can vary, and may not always be necessary or applicable.
Mastering the Option Contract Template
Using an option contract template can save you a lot of time. And the good news is that you don’t have to be a legal expert to craft an option contract. We’ve reviewed a number of templates for option contracts, and have developed a template for you to use for your real estate or professional business.
Essential Features of an Option Contract Template
The first and most crucial element in any option contract template is, of course, the option to purchase. An option to purchase is essentially two things: a right and an obligation. It is a right of the optionee and an obligation of the owner of an underlying property. The optionee has the right to exercise the option within a specific time frame, but the option does not require it. The option must be properly defined, identifying clearly what the purchase involves. A general description of the property in simple terms can suffice, or it can be defined in detail by referencing other sources. An address would be an obvious choice, but if available, a tax identification number can make for an even more precise description.
The next element is the purchase price. How much will the optionee pay, when they will pay it, and how will they pay it (e.g. check, wire transfer, etc.). The contract should also stipulate how taxes will be handled, and when they will be paid, as well as specifying who will be responsible for them (the buyer, seller, or both). Any other fees associated with the option and purchase should also be outlined.
It is not enough to simply determine a date on which the contract will expire. A well-drafted option contract will also include a clause that stipulates a method of extension, along with the conditions that must be met before such an extension can occur.
Advantages of Using an Option Contract Template
Using an option contract template is advantageous on many fronts. First and foremost, it serves as a sort of checklist of the important details that need to be included in the document. Forgetting even one of these details could have unintended consequences for the buyer or seller. An option contract template also ensures that all of the legal requirements of such a document are met. Any deficiencies in the document could weaken your legal standing if you needed to take the contract to court. Even if you’re not worried about enforcing your rights, following the letter of the law with your option contracts is key to keeping buyer and seller protected from legal action in the first place. From a practical standpoint, using a pre-made document saves you time and mental energy. If you’ve been through the process of creating an option contract before, you already know how complex it can be. Copying and pasting pre-written terms into the relevant sections of your own document eliminates the need to reference other contracts to find the right language to use. It’s also an opportunity to save time by combining contract creation with other work, such as your regular real estate tasks.
How to Customize Your Option Contract Template
In many instances, an option deal will not be a straight forward agreement and will require some form of alterations to the option contract template to accommodate the specific commercial arrangements being entered into. Several factors will usually determine the extent of the customization that is required to an option agreement.
Jurisdictional Requirements
The first consideration you should have when customizing an option contract template is whether the law which governs the agreement requires certain clauses to be included or a statement to be made. For example, if you are entering into an option agreement within Australia, you need to check whether the jurisdiction requires disclosure of certain material information. As with all agreements, it is good practice to review the governing law and jurisdiction in your agreement. You may also wish to insert a clear governing law and jurisdiction clause if the provisions of the agreement may leave some room for interpretation as to which state or territory laws will apply.
Specific Terms
The option contract template you are using may need to include specific terms such as the timing and manner in which any disclosure to registered participants occurs in the context of a float option, the methodology for calculating the hurdle exercise price or the specific manner in which the relevant entity is valued. These considerations and any other substantive issues will need to be explored together with the client before an option contract template is issued. It is likely that your client and its advisors will already have a clear track of the matters that are to be addressed in the option deed but it is recommended that a review of any specific requirements are addressed at the earliest possible opportunity.
Legal Advice
Although it is good practice to obtain legal advice when a client is customizing an option contract, there are some areas that are particularly sensitive to risk and legal advice is strongly recommended (even if it is not required) in these situations. Examples include:
Option Contract Template Mistakes to Avoid
Enforceability of option contracts can also be impacted by the use of the template, particularly with respect to the specific type of option contract. That is to say, one particular problem we have seen happen is where a client selects a simple lease option contract rather than a purchase option contract, they are not 100% similar. The lease option agreement contains specific language contemplating that the optionee would be a tenant of the property before "closing" however in the case of a purchase option agreement, the parties have not created a landlord/tenant relationship and should not create that intention.
Another common mistake is failing to sign the agreement properly. Often, when companies are involved, people take it for granted that the agreement is properly signed. The truth is, attorneys and real estate professionals have seen so much of this type of misconduct that it is not surprising that a few standard mistakes are made with signing. Usually , the signing party will sign for the company as the president, secretary or in some other corporate capacity. Nobody ever considered to check if this was actually correct. If the person who signs does not in fact have the authority to bind someone on behalf of the company, the failure to sign properly would make the contract voidable.
Incorrectly checking or failing to check a box on the template is another common mistake we have seen. A contract with a checkbox next to one party offering one type of remedy for default and the other party checking the box next to an entirely different remedy is not going to work. That is because it is not clear whose offer is being accepted. Typically, a contract is void (or voidable) where the offer is not properly accepted by the offeree. Taking that a step further, you can also mess up essential elements of an enforceable agreement by failing to initial or sign a page, by leaving a phrase or sentence blank and by the incorrect use of terms.
How to Select the Right Option Contract Template
The selection process is relatively straightforward, but you should still consider a few factors to ensure you have picked the right one for your needs. First, check the quality of the template. A poor-quality template is riddled with errors or minor issues. Such templates are often offered for free by people with no legal background. Trying to use one of these – out of sheer eagerness to save money – will likely end up costing more than you saved. Even if everything is written in perfect legalese, it still will not apply to your situation if it is not relevant to the specific transaction at hand. Therefore, review the clauses and language carefully. Does the template suit your situation? The last thing you want to be doing is going through additional effort to modify the document. You want to be spending your time writing that great book you’ve had stewing in your mind for the last ten years.
Finally, consider the source. This may go without saying, but check the qualifications of the person who wrote the contract. Using a contract template from a reputable source – like our website – is preferable to using one found on Ask.com. You could also find free resources from legal clinic websites. Avoid relying on one-of-a-kind templates you find online. It is certainly possible that other people have used them as well, which means your lawyer could point out certain clauses or language that were struck down or deemed inappropriate or unusual in other situations. Unfortunately, the person whom you found to be willing to share their contract did not update their version before posting it online.
Sources for Authentic Option Contract Template
Reliable option contract templates can often be found in well-known places. Licenced indisputable contracts are occasionally available from industry journals, trade organizations or even governing bodies. However, such contracts are often too narrow to apply universally. Most option contracts are variable and need to be interpreted before use.
Universally available internet contracts are also a possible source, but those that are provided free of charge should be used with care and the provider checked. It is always better to opt for one where people are prepared to commit to a minor payment in order to ensure proper qualification of the contract template.
Many legitimate law sites offer a free trial, but most require a valid credit card to sign up and only issue user agreements on the basis of address, phone numbers and credit card information . This often guarantees a certain level of gambling protection. When parting with financial details online be aware that numerous sites have been set up by unscrupulous criminals and many of them fish around the web to garner personal details for illegal purposes. Check reviews of any legal information website you may wish to use and cross check multiple review options. Most sites will have a history which can be verified with a modicum of effort on the user’s part.
Alternatively, one can engage an established corporate attorney to provide a copyright based contract. Normally this should improve the accuracy and reliability of the contract since it is the product of a team of experts rather than the work of a single individual who may not have legal training.