Put and Call Option Agreements: Are They Beneficial and When Can They Be Used?

Written by Shelby Sommerfeld

In a competitive market, it can be difficult to decide when timing and consideration is ideal to transact and conduct business. Whether purchasing or selling property, shares, assets or inventory, negotiating a merger, or completing a share buy-back – timing is of the essence.  A Put and Call Option Agreement (Option Agreement) can act as a bridge; creating flexibility for the Buyer, while offering comfort to the Seller in maintaining control over the timing and terms of the Agreement. Such Agreements can offer cost control in a fluctuating market, manage uncertainty, and act as a vessel to achieve strategic business objectives which otherwise may have resulted in missed opportunities without the mechanisms an Option Agreement provides for.

What is a Put and Call Option Agreement?

A Put and Call Option Agreement is a contractual agreement between a (potential) Buyer and (potential) Seller that allows the subject matter of the contract, whether that be property or assets, to be purchased at a future date for a predetermined price on predetermined terms and conditions. The future date is determined by the Put and Call Option periods and their relevant expiry dates.  Entering into an Option Agreement does not guarantee the sale of the property or asset but rather guarantees the option to exercise the right to purchase (by way of a call option), or in the instance of the Seller, the option to exercise the right to sell (by way of a put option). For instance, where the subject matter is real property, the contract of sale is only properly formed upon the exercise of either the Put or Call Options under the Option Agreement. The resulting contract must be annexed to the Option Agreement; it is important the formal purchase contract is viewed by both parties and the terms are agreed upon prior to entering into the Option Agreement.

Deferring the formation of the resulting sale contract while nonetheless effectively committing the parties to proceed with the proposed transaction offers strategic advantages to the Buyer and Seller for a range of commercial and taxation-related purposes, including:

• postponing the point at which stamp duty becomes payable on the underlying resulting contract;
• deferring the disposal date of a capital asset so that it falls within a later income year;
• delaying the purchase price payable allowing the parties further time to conduct due diligence and to obtain finance;
• where permitted under the Agreement, providing the Buyer the opportunity to nominate another entity to enter the purchase contract;  thereby facilitating anon-sale of the property to a third party without the need for the Buyer to first enter a formal dutiable contract; or
• allowing a builder to secure land with the intention of selling onto a third party intending to acquire a house-and-land package.

Call Option Period:

The Call Option period comes first in time and during this period the Buyer has the right, but not the obligation, to purchase the property or asset through exercising their Call Option under the agreement.

In return for the Seller granting the option to the Buyer to purchase during a specified period at a predetermined price, the Buyer pays a Call Option Fee which is usually nonrefundable and acts as security to the Seller that in the event the Buyer does not exercise their option, or the option lapses. The option fee essentially reserves the Buyers exclusive right to purchase during the Call Option period. In exchange for the Seller granting the Buyer an exclusive opportunity to purchase during the Call Option period, the call Option Fee paid by the Buyer to the Seller is non-refundable.

Put Option Period:

If the Call Option is not exercised prior to its expiry date it lapses and the Put Option Period begins. At the expiry of the Call Option, the Seller can compel the Buyer to purchase the land or asset which can also be referred to as the Seller putting the option to the Buyer.  If the Buyer has not nominated a third-party Buyer, the Seller becomes the option holder and can compel the Buyer to purchase for the agreed upon price. If the Buyer refuses to it would be deemed a breach under the contract.

Alternatively, if both parties decide not to exercise the option, the Option Agreement lapses and both parties walk away from the proposal, however the Seller still retains the Call Option Fee paid by the Buyer in return for holding the Buyers exclusive opportunity to purchase during the specific period.

Option Agreements in Context:

In the development sphere, Put and Call Option Agreements are commonly used by developers and builders with great success. For instance, a residential developer (Seller or Landowner) may offer several vacant lots to a smaller developer (Buyer) to be purchased at a later stage once planning permits, subdivision and zoning take effect. The Put and Call Option dates can be set to be triggered by certain events such as land registration or council building approval.

This provides flexibility to the Seller in ensuring the lots have a secured sale at a certain date but also allows the Seller time to obtain permits and liaise with surveyors for registration. During this period the Buyer can also conduct their due diligence, undergo crowd funding processes or in circumstances where the Agreement permits, find a third-party buyer to nominate to purchase the land before the Call Option period expires. The third-party buyer could be a builder that has the capability to sell house and land packages, or the initial Buyer that entered the Option Agreement could on-sell the land to a third-party Buyer at a higher price post Option Agreement.

In Queensland this mechanism is particularly useful as Buyers may nominate a third party to exercise the option and purchase the property without attracting adverse stamp duty consequences. However, other states and territories do not take the same approach, and the nomination can be seen as a second dutiable transaction attracting double stamp duty. A Put and Call Option Agreement can be a powerful tool in the hands of a well-informed buyer, however it is important to ensure the Options are exercised correctly, notice of disclosure is provided and each party’s obligations are clearly spelt out under the Agreement.

While Put and Call Options are often used in the context of real estate, the mechanisms can also offer flexibility in other transactions. 

Business Sales, Mergers and Acquisitions:

Option Agreements can provide exit strategies for business owners that wish to sell their business but are unable to do so conventionally as they play a major role in the business’ operation and are seen to be attached to the business’s goodwill. An Option Agreement can incorporate terms that allow the founder to remain working in the business for an agreed period on agreed terms. This exit strategy provides a means for the business owner to sell their business as a profitable business as opposed to the owner closing the business or selling for less value.

Shareholder Agreements and Share Sales:

Such agreements are also beneficial in share sales, where they can provide mechanisms for the orderly transfer of shares and delay tax obligations. The transfer of shares can trigger a CGT event (Capital Gains Tax) and a Put and Call Agreement can offer flexibility when the parties aren’t in the commercial or financial position to transact immediately.

Looking Ahead:

Whether purchasing property but requiring further time to conduct due diligence enquiries, raise funds or obtain relevant building permits; or selling shares and wanting to give key staff the opportunity to buy shares and invest as part of an incentive scheme, an Option Agreement can pave the way to achieve such strategic objectives. While Option Agreements are not an umbrella approach to conducting business, in certain circumstances they can be a useful legal mechanism for the right parties hoping to achieve the desired outcome when the terms are clear, the exercise dates are properly managed, and the Agreement is accurately structured to comply with the relevant legal requirements.