Option as a Preparatory Contract
An option contract is a separate agreement by which one party grants another the privilege to buy or sell a determinate thing for a fixed or determinable price within a stated period. It is preparatory because it does not by itself transfer ownership or compel the optionee to buy or sell. It keeps an offer alive for the optionee, who alone decides whether to convert the privilege into a sale or other principal contract.
The Civil Code rule on an accepted unilateral promise to buy or sell is the central rule: the promise is binding upon the promisor if it is supported by a consideration distinct from the price. The promise must involve a determinate thing and a price certain, because acceptance of the option must be capable of perfecting a definite sale without further negotiation on essential terms.
The grantor of the option is bound to respect the stipulated period when the option has its own consideration. The optionee is not bound to purchase or sell merely because the option exists. Until valid exercise, the optionee's principal obligation is normally limited to paying the option consideration, observing conditions imposed on exercise, and acting within the option period.
Accepted Unilateral Promise and Bilateral Promise
A bare offer is not yet an option contract. It becomes an option when the offeree accepts the privilege to decide later and the privilege is supported by a separate consideration. Acceptance of the option is different from acceptance of the sale. The first acceptance creates the option contract; the second acceptance, made by exercising the option, perfects the sale if the terms are complete.
A unilateral promise to sell binds only the promisor if the optionee may choose whether to buy. A unilateral promise to buy binds only the promisor if the optionee may choose whether to sell. In both cases, the optionee's power lies in election, not in an existing duty to complete the transfer.
A bilateral promise to buy and sell a determinate thing for a price certain is reciprocally demandable. In that situation, each party is already bound: one to sell and the other to buy. It is not a mere option, because neither party retains a free choice to refuse performance after the meeting of minds.
Essential Requisites
A valid and enforceable option contract requires a meeting of minds on the privilege granted, the subject matter, the price or price formula, the period or event for exercise, and the option consideration when the promisor is to be bound not to withdraw the offer.
- Determinate subject matter. The thing must be identified or capable of identification without a new agreement. A promise to sell any property the owner may later choose is ordinarily too indefinite to support compulsory sale.
- Price certain or ascertainable. The price must be fixed, or must be determinable by a method agreed upon, such as a valuation formula, an appraised value, a market reference, or a designated third person's determination.
- Option period. The time for exercise must be stated or reasonably ascertainable. If no period is fixed, the nature of the transaction and surrounding terms determine whether a reasonable period was intended.
- Separate option consideration. The cause of the option must be distinct from the purchase price, even if the parties agree that the amount paid for the option will later be credited to the price upon exercise.
- Communication of exercise. The optionee must communicate an absolute and timely exercise of the option in the manner required by the agreement or, in default of stipulation, by a method that clearly reaches the optionor.
Option Consideration
Option consideration, often called option money, is the price paid or promised for the privilege of keeping the offer open. It is the consideration for the option contract itself, not the price of the thing to be sold. It may consist of money, a promise, a concession, forbearance, or another valuable undertaking that the parties treat as the cause of the option.
The requirement that the consideration be distinct from the price means that the law looks for a separate juridical reason for the optionor's obligation to wait. The same amount may be credited to the purchase price if the option is exercised, but it must first have been given or promised as the price of the option privilege.
If the option is supported by separate consideration, the optionor may not defeat the option by withdrawing the offer during the option period. An attempted revocation is a breach of the option contract and does not destroy the optionee's right to exercise according to its terms.
If the unilateral promise is not supported by separate consideration, the promisor is generally free to withdraw the offer before acceptance. The withdrawal must be communicated before acceptance becomes effective. If the optionee accepts the offer before learning of an effective withdrawal, the sale may still be perfected because consent to the sale has already been completed.
Option Money and Earnest Money
| Point of comparison | Option money | Earnest money |
|---|---|---|
| Function | Consideration for the privilege to buy or sell later | Part of the purchase price and proof of a perfected sale |
| Stage of transaction | Given before the sale is perfected, unless the option is later exercised | Given after the parties have agreed on the object and price |
| Duty of recipient | Keep the offer open during the option period if the option is binding | Perform obligations under the perfected sale |
| Duty of payor | No duty to buy or sell unless the option is exercised | Duty to pay the balance of the price and comply with the sale |
| Effect of non-exercise | No breach by the optionee, subject to contrary stipulation | Nonpayment or refusal to proceed may constitute breach of the sale |
| Application to price | Applied to price only if agreed or necessarily implied | Automatically treated as part of the price |
Exercise of the Option
Exercise of an option must be clear, unconditional, and made within the option period. A qualified acceptance, a request to renegotiate, or an acceptance that changes material terms is a counteroffer, not an exercise. The optionee must accept the offer as it stands, because the optionor agreed to be bound only on the stated terms.
Payment of the purchase price is not always required for effective exercise. If the option merely requires notice of acceptance, timely notice perfects the sale and payment becomes a resulting obligation. If the option expressly requires payment, tender, deposit, execution of documents, or performance of a condition as the mode of exercise, the optionee must comply within the period.
Upon proper exercise, the option ceases to be merely preparatory and the parties' relationship is governed by the resulting contract. If the option is to buy a thing for a fixed price, exercise ordinarily perfects a contract of sale. If the terms show that title is to remain with the seller until full payment or fulfillment of a suspensive condition, exercise may instead create or activate a contract to sell.
An exercise made after the option period is ineffective unless accepted by the optionor as a new agreement. Time is material because the optionor's obligation to keep the offer open exists only within the agreed period. Where the period expires on a date fixed by the parties, the optionee cannot revive the privilege by unilateral tender after expiration.
Withdrawal, Rejection, and Lapse
A binding option cannot be withdrawn during the option period without liability. The optionor's sale to another, refusal to honor a timely exercise, or conduct making performance impossible is a breach of the option and, after valid exercise, may also be a breach of the perfected sale.
An option lapses when the period expires, when the optionee rejects the offer, when the subject matter is lost without the optionor's fault before a sale is perfected, or when a condition for exercise fails. Rejection terminates the option because the optionee has renounced the privilege that the optionor agreed to keep available.
If the option is unsupported by consideration, death, civil interdiction, insanity, or insolvency of either party before acceptance may render the offer ineffective under the general rules on offers. A supported option, being a separate contract, is generally transmissible to heirs and assigns unless the agreement, the nature of the obligation, or the law makes the privilege personal.
Form, Writing, and Proof
No particular form is required for an option contract as a general rule, because contracts are obligatory in whatever form they are entered into when the essential requisites are present. Form becomes important when the law requires writing for enforceability, public instrument for convenience and registration, or specific authority for an agent.
When an option concerns immovable property, interests in immovable property, or another transaction covered by the Statute of Frauds, a written note or memorandum is necessary for enforcement while the agreement remains executory. The writing should identify the parties, describe the property, state the price or means of fixing it, show the option period, and reflect the option consideration or the basis for treating the offer as irrevocable.
A public instrument is not generally essential to the validity of an option over immovable property between the parties, but it facilitates registration, notice to third persons, and later execution of the deed of sale. For registered land, annotation of the option or related instrument protects the optionee against subsequent dealings inconsistent with the option, subject to the rules on registration and good faith.
When an agent grants or accepts an option intended to result in the sale of land, written authority should exist because the resulting sale of land through an agent requires written authority. Without sufficient authority, the principal may not be bound by the supposed option or the later sale.
Relation to Sale and Contract to Sell
An option is not the same as a sale. In a sale, consent on object and price creates reciprocal obligations to deliver and pay, and ownership passes by delivery. In an option, the optionor is bound to keep the offer open, but the optionee has no duty to complete the purchase unless the option is exercised.
An option is also different from a contract to sell. In a contract to sell, the prospective seller binds himself to sell only upon fulfillment of a suspensive condition, commonly full payment of the price. The buyer is already committed to meet the condition. In an option, the optionee is free to let the privilege expire, unless the parties added separate undertakings.
The distinction matters for remedies. Before exercise, the optionee normally cannot demand delivery of the thing, because there is no sale yet. After exercise, the optionee may demand the execution of the sale, delivery, or other performance required by the perfected agreement, subject to payment, tender, or conditions imposed by the contract.
Right of First Refusal Distinguished
A right of first refusal gives its holder the preferential opportunity to buy if the owner decides to sell to someone else. It usually does not fix all essential terms in advance and does not by itself give the holder an immediate power to compel a sale. The owner must first decide to sell and must disclose the terms on which a third person may purchase so the holder can match them.
An option gives a more definite power. The optionee can accept the standing offer within the period and compel the optionor to proceed according to the agreed terms. Because an option already contains the essential elements of the future sale, the optionee need not wait for a third-party offer or a later decision by the owner to sell.
A clause called a right of first refusal may operate as an option if it fixes the property, price, period, and privilege to buy without dependence on a third-party offer. Conversely, a clause called an option may be only a preference if essential terms are left to future negotiation.
Lease with Option to Buy
A lease may contain an option allowing the lessee to purchase the leased property within the lease term or upon its expiration. The lessee's possession as tenant does not itself prove exercise of the option. The lessee must comply with the required notice, timing, payment, and other conditions stated in the option clause.
Rent is not automatically option money. It may support an option only when the lease shows that part of the rent, a higher rent, or another concession was intended as consideration for the purchase privilege. If the purchase option is separately supported and timely exercised, the lessor must perform the resulting sale according to the agreed terms.
Effects Against Third Persons
An option contract is primarily a personal obligation between the optionor and optionee. It does not create ownership in favor of the optionee before exercise and delivery. A third person who acquires the property in good faith, for value, and without notice may be protected, especially in dealings involving registered land.
If the third person had notice of the option or acted in bad faith to defeat it, the optionee may pursue remedies that reach the property when the requirements for enforcement are present. Annotation on the certificate of title, possession consistent with the option, or actual knowledge may affect the third person's claim of good faith.
After a valid exercise, the optionee becomes a buyer under the resulting contract and may invoke the remedies available to a buyer. If the property has already been transferred to an innocent purchaser, the optionee's practical remedy may be damages against the optionor rather than recovery of the property.
Remedies
For breach of a binding option before exercise, the usual remedies are damages, enforcement of the option during the period, and other relief appropriate to preserve the optionee's contractual privilege. The measure of relief depends on whether the option can still be exercised and whether the subject matter remains available.
After timely and valid exercise, the optionee may seek specific performance of the sale when the object and price are definite and the optionee is ready to comply with corresponding obligations. If specific performance is no longer possible, damages may be awarded for the optionor's breach.
The optionor may enforce payment of the option consideration if it was promised and unpaid. The optionor generally cannot compel the optionee to buy or sell before exercise, because the optionee's freedom of election is the essence of the option.
Practical Legal Effects
- An option supported by separate consideration makes the offer irrevocable during the agreed period.
- An option without separate consideration may still result in a perfected sale if accepted before effective withdrawal.
- Exercise of the option must match the terms of the offer and must be communicated within the option period.
- Option money pays for the privilege; earnest money evidences and forms part of an existing sale.
- An option over land should be in writing for enforceability and should be registered or annotated when protection against third persons is intended.
- Before exercise, the optionee has no ownership and ordinarily no right to delivery; after exercise, the rights depend on the resulting sale or contract to sell.