What is a contract option?

An option is a simple choice, however where a contract is involved it has a more specific meaning. An option is an enforceable discretionary right of one party to bring into effect a contract with another party, by a unilateral act of exercising an option. In Mackay v Wilson (1947) the court held that an option is “nearly always a ticklish thing”. This comment reflects the imprecise legal nature of an option and the differing meanings the courts have attributed to the term. An example of where options may occur include:

options to acquire or sell land or to renew leases;
options to acquire or sell shares or to have shares issued;
options in finance transactions which confer a right (or impose an obligation) to acquire;
options which are traded on stock exchanges and as over-the-counter options.

Options have also been used in finance transactions as part of the security available to a lender in the event of default by a borrower. An example is where a third party to the lender grants a ‘put option’ to the lender that if the borrower defaults, and the lender provides notice to the third party, the third party will buy the lenders debt.

There are various ways options can be used in commercial transactions, and each situation requires careful assessment to determine the rights and obligations in respect to the option for each party to the contract.

The word ‘option’ is not a term of art and does not itself define the quality, nor the quantity of the interest with regard to which the option is given. The meaning of the word is based on the context in which the word is used. The legal use of the word option is used in the respect that the party to the contract that is granted the option in a contract is not bound to do anything until the option is triggered to act upon.

Options to buy property may be referred to as ‘call options’, and options to sell property are called ‘put options’. Explaining this another way a ‘call option’ is where one party grants to another party the right to acquire an asset from the first person at a specified date, time and price; and a ‘put option’ is where one party grants to another party who owns an asset the right to require the first person to acquire the asset.

A party who has been granted an option has strict compliance to comply with the conditions of the option. As example in Hare v Nicole [1966] an option relating to shares required the optionee (the party granted the option) to pay their price before 1 June 1963. The optionee failed to pay the price for the shares on the due date. The optionee made a claim against the optionor (the party that issued the option) to issue the shares. The court held the optionee was unable to enforce the optionor’s obligation to issue the shares, as the optionee had failed to pay for the shares by the due date.

Generally, it does not matter whether a contractual right is called an option, as the relevant clause in the contract needs to be assessed to determine what the parties are required to do, and what rights or obligations are required to be complied with. However, where the subject matter of the contract refers to statutory provisions and references the word option, then it does matter that the word option is used in the specific contract clause.
Options are founded on the law of contract, and contract principles need to be present to make the option valid. Some of the principles include: consideration must apply; the terms of the option must be certain; where the option effects land it must be in writing; the person granting the option must have the authority to do so; the option must be free from restraints of the perpetuities rule, or other types of restraints; the option cannot involve any fraud, misrepresentation or other illegality; the option must not be granted under any breach of fiduciary duty.

Contract options in an agreement require careful review to determine the rights and obligations of the parties to the agreement. It is not uncommon for a party to fail to exercise an option on or before the due date. This is usually because there is insufficient administrative follow up in regard to the contract. Contracts even simple looking ones may contain complex option clauses. The prudent solution is before signing a contract is to get that legal advice to protect your legal rights and interests.

The comments in the aforementioned do not constitute legal advice and are general in nature, and if legal advice is required please contact: John Melis at Legal AU Pty Ltd (03) 9999 7799 www.legalau.com

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