OPTION CONTRACTS & INSTALLMENT SALES CONTRACTS
OPTION CONTRACTS
Essential characteristics 
/ Contract requirements / Common provisions / Legal aspects
Essential characteristics
An option-to-buy is an enforceable contract in which a potential seller, the optionor, grants a potential buyer, the optionee, the right to purchase a property before a stated time for a stated price and terms. In exchange for the right of option, the optionee pays the optionor valuable consideration.
For example, a buyer wants to purchase a property for $150,000, but needs to sell a boat to raise the down payment. The boat will take two or three months to sell. To accommodate the buyer, the seller offers the buyer an option to purchase the property at any time before midnight on the day that is ninety days from the date of signing the option. The buyer pays the seller $1,000 for the option. If buyer exercises the option, the seller will apply the $1,000 toward the earnest money deposit and subsequent down payment. If the optionee lets the option expire, the seller keeps the $1,000. Both parties agree to the arrangement by completing a sale contract as an addendum to the option, then executing the option agreement itself.
An option-to-buy places the optionee under no obligation to purchase the property. However, the seller must perform under the terms of the contract if the buyer exercises the option. An option is thus a unilateral agreement. Exercise of the option creates a bilateral sale contract where both parties are bound to perform. An unused option terminates at the expiration date.
An optionee can use an option to prevent the sale of a property to another party while seeking to raise funds for the purchase. A renter with a lease option-to-buy can accumulate down payment funds while paying rent to the landlord. For example, an owner may lease a condominium to a tenant with an option to buy. If the tenant takes the option, the landlord agrees to apply $100 of the monthly rent paid prior to the option date toward the purchase price. The tenant pays the landlord the nominal sum of $200 for the option.
Options can also facilitate commercial property acquisition. The option period gives a buyer time to investigate zoning, space planning, building permits, environmental impacts, and other feasibility issues prior to the purchase without losing the property to another party in the meantime.
Contract requirements
To be valid and enforceable, an option-to-buy must:
- include actual, non-refundable consideration
The option must require the optionee to pay a specific consideration that is separate from the purchase price. The consideration cannot be refunded if the option is not exercised. If the option is exercised, the consideration may be applied to the purchase price. If the option is a lease option, portions of the rent may qualify as separate consideration.
- include price and terms of the sale
The price and terms of the potential transaction must be clearly expressed and cannot change over the option period. It is customary practice for the parties to complete and attach a sale contract to the option as satisfaction of this requirement.
- have an expiration date
The option must automatically expire at the end of a specific period.
- be in writing
Since a potential transfer of real estate is involved, Florida’s statute of frauds requires an option to be in writing.
- include a legal description
- meet general contract validity requirements
The basics include competent parties, the optionor’s promise to perform, and the optionor’s signature. Note that it is not necessary for the optionee to sign the option.
Common provision
Beyond the required elements, it is common for an option to include provisions covering:
- how to deliver notice of election
A clause clarifies how to make the option election, exactly when the election must be completed, and any additional terms required such as an earnest money deposit.
- forfeiture terms
A clause provides that the optionor is entitled to the consideration if the option term expires.
- property and title condition warranties
The optionor warrants that the property will be maintained in a certain condition, and that title will be marketable and insurable.
- how option consideration will be credited
A clause states how the optionor will apply the option consideration toward the purchase price.
Legal aspects
Equitable interest. The optionee enjoys an equitable interest in the property because the option creates the right to obtain legal title. However, the option does not in itself convey an interest in real property, only a right to do something governed by contract law.
Recording. An option should be recorded, because the equitable interest it creates can affect the marketability of title.
Assignment. An option-to-buy is assignable unless the contract expressly prohibits assignment.
INSTALLMENT SALES CONTRACTS
Interests and rights Legal form Default and recourse Usage guidelines
An installment sale contract for deed is also called a land contract, a contract for deed, a conditional sales contract, and an agreement for deed. It is a bilateral agreement between a seller, the vendor, and a buyer, the vendee, in which the vendor defers receipt of some or all of the purchase price of a property over a specified period of time. During the period, the vendor retains legal title and the vendee acquires equitable title. The vendee takes possession of the property, makes stipulated payments of principal and interest to the vendor, and otherwise fulfills obligations as the contract requires. At the end of the period, the buyer pays the vendor the full purchase price and the vendor deeds legal title to the vendee.
Like an option, a contract for deed offers a means for a marginally qualified buyer to acquire property. In essence, the seller acts as lender, allowing the buyer to take possession and pay off the purchase price over time. A buyer may thus avoid conventional down payment and income requirements imposed by institutional lenders. During the contract period, the buyer can work to raise the necessary cash to complete the purchase or to qualify for a conventional mortgage.
A contract for deed serves two primary purposes for a seller. First, it facilitates a sale that might otherwise be impossible. Second, it may give the seller certain tax benefits. Since the seller is not liable for capital gains tax until the purchase price is received, the installment sale lowers the seller’s tax liability in the year of the sale.
Interests and rights
Vendor’s rights and obligations. During the contract period, the seller may:
- mortgage the property
- sell or assign whatever interests he or she owns in the property to another party
- incur judgment liens against the property
The vendor, however, is bound to the obligations imposed by the contract for deed. In particular, the vendor may not breach the obligation to convey legal title to the vendee upon receipt of the total purchase price. In addition, the vendor remains liable for underlying mortgage loans.
Vendee’s rights and obligations. During the contract period, the buyer may occupy, use, enjoy, and profit from the property, subject to the provisions of the written agreement. The vendee must make periodic payments of principal and interest and maintain the property. In addition, a vendee may have to pay property taxes and hazard insurance.
Legal form
Like other conveyance contracts, a contract for deed instrument identifies:
- the principal parties
- the property’s legal description
- consideration: specifically what the parties promise to do
- the terms of the sale
- obligations for property maintenance
- default and remedies
- signatures and acknowledgment
The contract specifies the vendee’s payments, payment deadlines, when the balance of the purchase price is due, and how the property may be used.
Default and recourse Seller default. If the seller defaults, such as by failing to deliver the deed, the buyer may sue for specific performance, or for cancellation of the agreement and damages.
Buyer default. If the buyer defaults, Florida provides foreclosure proceedings as a remedy.
Usage guidelines
This kind of conveyance presents certain pitfalls for buyer and seller.
One danger for the vendee is that the vendor has the power and the right to encumber the property in ways that may not be desirable for the buyer. For example, the seller could place a home equity loan on the property, then fail to make periodic payments. The bank could then foreclose on the vendor, thus jeopardizing the vendee’s eventual purchase.
For the seller, the principal danger is that the buyer acquires possession in exchange for a minimal down payment. A buyer might damage or even vacate the property, leaving the seller to make repairs and retake possession. Further, since the contract is recorded, the seller must also bear the time and expense of clearing the title.
If the buyer defaults, the seller’s only recourse to retake possession is to initiate foreclosure proceedings. Meanwhile, the seller can be held responsible for injuries or actions that occur on the property.
To minimize risk, principal parties in a contract for deed should observe the following guidelines:
- use an attorney to draft the agreement
- adopt the standard forms, if available
- become familiar with how the contract will be enforced
- utilize professional escrow and title services
- record the transaction properly
- be prepared for the possible effect on existing financing
