Who gets to keep an option fee if the sale of land contract has been terminated?

In brief - This article examines the importance of understanding the terms and obligations in an option agreement and a sale of land agreement to ensure the parties involved do not lose entitlements to the funds should a dispute arise during a sale.

Background

If a sale of land contract arising from an option agreement is terminated, the terms of the option agreement and sale of land agreement will be examined closely to determine the entitlements of the vendor and purchaser.  

In J & Z Holding (Aust) Pty Ltd v Vitti Pty Ltd [2002] NSWSC 1718, the vendor terminated the sale of land contract (Contract) based upon a failure of the purchaser to complete the Contract when required by a notice to complete. The purchaser disputed the validity of the notice to complete and terminated the Contract based on the vendor's wrongful repudiation of the Contract. Both parties claimed to be entitled to the $2,050,000 paid by the purchaser for the call option fee disclosed in the put and call option agreement (as amended) (Option). 

The purchaser argued it was entitled to the funds

The purchaser contended that it was entitled to recover the deposit because:

• The $2,050,000 paid by the purchaser was considered a  deposit under the terms of the Contract
• The purchaser was entitled to the return of the deposit due to the vendor's repudiation of the Contract
• The deposit paid was considered a penalty as it was more than 10% of the purchase price of the Contract.

How to establish entitlements 

For the purchaser to succeed, the $2,050,000 had to be characterised as a deposit notionally paid under the Contract. 

In contrast, for the vendor to succeed, the $2,050,000 had to be characterised as an option fee that vested in the vendor at all material times and in substance, the amount represented no more than a credit to be allowed against the purchase price upon completion of the Contract.

Decision 

The Court held that the vendor could retain the $2,050,000 because: 

• The Option included the following terms: 
  • The amendment to the Option had provided the purchaser with an extension of the call option period
  • The call option fee "is and had been irrevocably and unconditionally forfeited and released" to the vendor
  • The purchaser acknowledged the vendor was entitled to keep all amounts paid as the call option fee
  • The Contract was exchanged pursuant to the Option
  • The call option fee was to comprise the deposit payable under the Contract
  • The Contract did not contain an obligation for the purchaser to pay a deposit, so the funds paid under the Option could not be considered a penalty.

Under the proper construction of the Option and the Contract, the $2,050,000 was not a conventional deposit. It was the vendor's property and a credit in reduction of the purchase price payable by the purchaser at completion of the Contract.

It is essential to understand your obligations and entitlement in any contract

Whilst the vendor was successful in retaining the $2,050,000, the Court noted  the vendor's notice to complete had been invalid and the vendor had wrongfully terminated the Contract. Normally, this would entitle the return of the deposit to the purchaser but in this case, there was no deposit and the purchaser had not claimed consequential relief, other than the return of the deposit.

This case is a stark reminder that parties need to clearly articulate the obligations and entitlements of any payment made pursuant to an option agreement and the sale of land contract. Parties must be vigilant in understanding their obligations when terminating any contract to avoid potentially losing entitlements to funds.