In a put and call option agreement for the sale of land, the option fee is commonly credited towards the deposit once the option is exercised. If a contract is terminated for a breach by a vendor, the purchaser can usually recover its deposit. But what happens to an option fee that has not been credited towards the deposit in this scenario? Will the purchaser get its money back? Find out here…

When selling or buying land, a vendor and purchaser may enter into a ‘put and call option’ agreement whereby the vendor is granted the right to require the purchaser to buy the land from the vendor (the put option) and the purchaser is granted the right to require the vendor to sell the land to the purchaser (the call option). Such an arrangement allows the parties to secure an interest to sell or buy the land at a future date, or upon the occurrence of a specified event.

Because they ultimately delay formation of a contract for sale, put and call options are used for various reasons including, in the case of purchasers, to delay payment of transfer duty on the purchase price while development approval and/or funding is obtained, and in the case of vendors, as a means of deferring capital gains tax obligations.(i)

Typically, a non-refundable ‘option fee’ is paid under a put and call option agreement, as consideration for the land being off market during the put and call option periods. The amount of the option fee is commonly up to 10% of the purchase price of the land and more in some instances.

Once a party exercises its put or call option under the agreement, a contract for the sale of land is created and the option fee is usually credited towards the deposit payable under the contract. A deposit under a contract for sale of land is considered an ‘earnest of performance’. That is, it demonstrates that the purchaser is sincere in its intention to fulfil its contractual obligation to purchase the land. If the vendor breaches the contract and the contract is terminated, the purchaser is generally entitled to recover its deposit, depending on the terms of the contract and the facts and circumstances of the termination.

In the recent case of J&Z Holding (Aust) Pty Ltd v Vitti Pty Ltd(ii), the Court of Appeal decided that the purchaser was not entitled to recover monies paid towards a “deposit” even though the vendor had breached the contract for sale of land.

The facts

Vitti Pty Ltd (Vitti) owned the commercial building located at 562-576 Harris Street, Ultimo NSW 2007 (the Property). J&Z Holding (Aust) Pty Ltd (J&Z) was a prospective purchaser of the Property. On 17 August 2018, the parties entered into a ‘Put and Call Option Agreement’ (the Put & Call Option) whereby Vitti granted J&Z an exclusive right to purchase the Property (the Call Option) for a period of 22 months (the Call Option Period). If J&Z did not exercise the Call Option during the Call Option Period, Vitti could exercise the put option (the Put Option) to compel J&Z to purchase the Property. If the Put Option was exercised, a binding contract for sale would be formed and J&Z would be compelled to purchase the Property for the sum of $10,250,000. J&Z was required to pay Vitti an option fee of $2,050,000 (Option Fee) (being 20% of the purchase price) as consideration for the grant of the Put & Call Option.

J&Z was unable to secure finance and faced the prospect of not being able to complete the purchase of the Property. Subsequently, the parties entered into a number of amending deeds, which extended the Call Option Period and “irrevocably and unconditionally forfeited and released” the Option Fee of $2,050,000 to Vitti. The parties agreed that if the Contract for Sale was exchanged, the Option Fee would comprise the deposit to be credited against the purchase price on completion. The parties labelled the $2,050,000 credit as the ‘deposit’ in the amending deeds.

J&Z failed to exercise its Call Option despite the extensions of time provided. Vitti then exercised its Put Option, which meant the Contract for Sale was formed and J&Z was obligated, but failed, to purchase the Property. Vitti served J&Z with a notice to complete, requiring J&Z to complete the purchase of the Property within 14 days. Vitti purported to terminate the Contract for Sale on the basis that J&Z had failed to comply with the notice to complete. Unfortunately, the termination notice was served too early, meaning Vitti was not entitled to terminate the Contract for Sale at that time. By doing so, Vitti had itself repudiated the Contract for Sale, giving J&Z the right to terminate the Contract. Rather than attempting to complete the purchase, J&Z then terminated the Contract for Sale for Vitti’s repudiation, and demanded return of the ‘deposit’ of $2,050,000.

Supreme Court decision

J&Z, as purchaser, sought the ‘deposit’ of $2,050,000 be returned to it because the vendor had wrongfully terminated the Contract for Sale. The main issue for determination was whether the sum of $2,050,000 was to be characterised as a ‘conventional deposit’, paid ‘in earnest’ to provide security for the performance of the Contract for Sale, or whether the $2,050,000 was an option fee unconditionally paid to the vendor in exchange for the purchaser’s exclusive right to purchase the Property during the Call Option Period (as extended).

Justice Lindsay held that the $2,050,000 was not a deposit. Rather, the $2,050,000 was the vendor’s property, paid by the purchaser “for the grant, and extension of a call option, the operation of which [the purchaser] fully enjoyed”. His Honour considered the parties intended the Option Fee would be credited against the purchase price payable under the Contract for Sale at the time the purchase was completed. However this did not mean the $2,050,000 became a conventional deposit. Although the word ‘deposit’ was used in the amending deeds, in substance and character the $2,050,000 was the vendor’s property, which it was entitled to retain.

The NSW Court of Appeal

J&Z appealed the decision. The main issue for determination was whether the $2,050,000 was a non-refundable option fee that could be kept by Vitti (the vendor) as consideration for securing the purchaser’s exclusive right to purchase the Property. Or, whether the $2,050,000 was a conventional deposit that was required to be returned to J&Z (the purchaser) on the basis of the vendor’s repudiation.

The Court of Appeal denied the appeal and held that the $2,050,000 was an option fee paid by the purchaser in consideration for the grant of the Put & Call Option. This was despite the fact that the word ‘deposit’ was used in the amending deeds to describe the $2,050,000.

Key takeaway

In this case, the Court upheld the deal the parties intended to reach, even though it may have been misdescribed in the documentation. The purchaser got what it bargained for in its payment of the Option Fee. That is, it paid $2,050,000 for the grant and extension of the Call Option Period, which it fully enjoyed. The vendor had an absolute entitlement to the Option Fee, which was not surrendered when it exercised the Put Option. Upon the proper construction of the documents as a whole, the Option Fee was not a conventional deposit.

In this case the ‘deposit’ was the vendor’s property as an option fee which they were entitled to retain. It was not paid by the purchaser as an earnest of performance of the contract created by the vendor’s exercise of the Put Option.

It was a means of identifying an obligation on the part of the vendor to provide a credit in favour of the purchaser in reduction of the balance of the purchase price. The fact that the parties attached to the sum of $2,050,000 the label ‘deposit’ was not determinative of its true legal character.

This article by Deren Hassan and Diahna Angelis, Mills Oakley is published in the latest edition of SCN magazine.

(i) Note that in May 2022 there were changes to the Duties Act 1997 (NSW) which affect the treatment of option agreements and in particular option fees. These changes are not within the scope of this article. Parties should obtain professional advice on these changes prior to entering into any arrangement involving an option.

(ii) [2024] NSWCA 2.