Conditional Exchanges, Options to Purchase and Rights of First Refusal

The majority of the time when you are selling a property or when you find one you want to buy, you will want to exchange and complete as soon as possible. This won’t always be the case though. It might be that you want to reserve the right to buy a property at some time in the future, or that you want to give yourself the option to escape the contract if certain conditions are not met.

If you are thinking of entering into an arrangement whereby you are granting or reserving any kind of right in respect of the acquisition of a property there are several options and it is important to choose the right one for your situation. Of course it is always advisable to seek legal advice; however this article should offer a few pointers.

Conditional Exchanges

Usually an exchange of contracts will be unconditional, that is, the buyer is bound to buy and the seller is bound to sell and failure by either party to complete the contract on an appointed date will give rise to a claim for compensation by the defaulting party. A conditional exchange however offers an “escape route” for one or both parties. A contract can be conditional on more or less anything, but we will try to cover some of the more common ones here:

Imposing a Long Stop Date

Typically used when buying a new build, this is where contracts are exchanged but the buyer is only bound to complete if the seller is able to complete by a certain date. New properties have often not actually been built at the point of exchange and so it is not possible to set a fixed completion date and instead, completion will be, say, 10 working days after the builder has provided evidence, usually in the form of a notice from NHBC or a building control completion certificate, that the property is substantially completed and fit for occupation.

This might mean that completion will not take place for several months at least, and problems with the construction could mean it is even longer. Nonetheless, the buyer is still bound into the contract for as long as it takes unless a long stop date is agreed. If it is, then when this date is reached and if the seller is not ready to complete, the buyer may choose to continue to wait or may choose to void the contract and walk away.

If he chooses to void the contract then although it depends on the wording of the contract, he will not usually be entitled to compensation. It simply means he can walk away without risk of being sued by the seller. If the clause is properly drafted then, if the buyer chooses not to enforce the long stop condition immediately, he should still be able to enforce it at any point before the seller has given notice he is ready to complete.

Exchange Conditional on Satisfactory Search Results

In order to bring forward an exchange of contracts, a buyer may offer to exchange before he has received his search results on the condition that should they be unsatisfactory he will be able to void the contract and will not be obliged to complete. This can be dangerous and should be used with caution as “unsatisfactory search results” can be a subjective term and depending on the entry that is concerning the buyer could lead to a protracted and expensive legal argument.

Exchange Conditional upon Receipt of a Satisfactory Mortgage Offer

Similar to the above, this is risky because an argument could arise as to what constitutes “satisfactory”. The purchaser may receive an offer than would allow him to complete the purchase however he may not be happy with the rate or the amount the lender is willing to lend, though it might be possible to agree a range of values beforehand and incorporate these into the clause, for example “a mortgage offer shall be considered satisfactory provided the interest rate is no greater than X%, the term is no greater/no less than X years and the amount of lending is not less than £X”

Exchange Conditional on the Completion of a Connected Transaction

Where a buyer/seller is also selling/buying and he is relying on the proceeds of sale to complete the purchase from you or if he is selling to you, needs to be able to move into his new property on completion of the sale to you, but that connected transaction is not ready, it might be beneficial to exchange conditional on that dependent transaction proceeding.

A clause might be added to allow him to void the contract if his dependent transaction has not exchanged by a given date and to fix a completion date to tie in with his dependent transaction if the matter does proceed. Of course, all he would need to do to escape the contract would be to delay his dependent transaction until after the cut off date.

Options to Purchase

An option to purchase is an agreement between two parties whereby the owner of a property agrees with a potential purchaser that the purchaser may buy the land at any time before an agreed date and at a fixed price. The would be purchaser will pay a premium for the option. He will not be obliged to buy the property at all but the premium he has paid will not be recoverable if he does not. It therefore acts as a kind of non-refundable deposit.

The owner of the property is not permitted to sell to anyone else during the option period and the option should be registered as a notice on the title to the property. The option period can be anything, depending on the would be buyer’s reason for wanting the property. If he intends to conduct a sub-sale, where he buys the property and immediately sells it on at a higher price, the period can be very short however if the property is a piece of land with future development potential he might take an option now while prices are low with an option period of 10 years, in the hope that by that time prices will have risen again and he can make a profit.

Rights of First Refusal

Sometimes when a property is sold the seller will want to reserve a right of first refusal so that if his buyer intends to sell he has to first offer it back to him. Councils do this when they sell properties under the right to buy scheme so that they can try to avoid their housing stock from becoming too low.

There may be other reasons, for example a person may sell his property to an investor because he is struggling to pay his mortgage. In this case he may want to buy it back when his financial circumstances improve. Having the benefit of a right of first refusal does not allow the beneficiary to force the owner to sell; it only means that if he does, he must offer the property to the beneficiary.

It is important to specify either a fixed price that the beneficiary must pay or else that he must pay market value.

Providing for Additional Premiums to be Payable Following Resale

It is possible to include a covenant in a transfer to a purchaser that upon sale, the new owner has to pay a portion of the sale price to the former owner. This is known as a clawback provision. It is usually used where undeveloped land is sold and will state that should the land be developed, which obviously increases the value greatly, the original owner is entitled to a share of the profit.

Sometimes it is used to try and prevent the land from being developed in future, for example by making it not financially viable once the clawback payment has been made.


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One Response to “Conditional Exchanges, Options to Purchase and Rights of First Refusal”

  1. Yes, and theres one for every guru who wants to sell you something!

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