Development Sites – Option v Promotion Agreement
When assembling land into a development site, it has been customary to enter into an option agreement with the land owner. It may however, in some circumstances be better to enter into a promotion agreement. In this article, we explain what each are, the differences between Option agreements and Promotion agreements and when to use each.
Option Agreement
An option agreement is a form of contract for the sale of land. As far as contracts go, option agreements are an oddity because the substance or purpose of the contract will not complete for some time, in some instances several years. That’s assuming of course the option is exercised and the contract is completed at all!
The option agreement gives the holder of the option a unilateral right to acquire the land which is the subject matter of the agreement subject to the conditions named in the option agreement being satisfied and of course subject to the other terms in the agreement.
Promotion Agreement
A promotion agreement, (sometimes referred to as land promotion agreement or development promotion agreement) is a form of contract that mimics the appearance of an option agreement and may well include options for the promoter/developer to acquire the land. The parties to a promotion agreement are usually the land owner and the ‘promoter’ who is usually a developer.
Contrasting Option Agreements & Promotion Agreements
Under a promotion agreement, the promoter (developer) uses its expertise first, to promote the land or property for development usually in the context of the local development framework plan then applies for and secures planning permission. The planning permission would usually be for the form of development project agreed with the land owner – naturally this has to be viable and suitable for both parties. The promoter (developer) then promotes the property (with the benefit of planning permission) in the open market for sale.
Promotion agreements will be more appealing to developers and sourcing agents especially in the current climate, with high acquisition costs associated with Stamp Duty Land Tax and finance.
Promotion agreements are also beneficial since it effectively places both the land owner and the developer promoter on the same side of the table since they are both working together to achieve a common purpose. Both land owner and developer promoter would share in the benefit of enhanced values of the development site and thus both parties have an interest to maximise those values.
The relationship between the parties in a promotion agreement can thus be contrasted with an option agreement which is exercisable after the grant of planning permission. Under most commonly drafted option agreements, the land is valued at the stage when the option agreement is entered into, i.e. before the enhanced value added by securing planning permission. The developer could thus sit and wait until the economic climate suits the developer to apply for planning permission then subsequently exercise the option. An option agreement therefore naturally favours a developer-purchaser because it minimises the value of the land at the point the option agreement is entered into whilst the planning permission secured may enhance the value considerably.
To cater for this gap in objectives, overage provisions are included in option agreements to deal with enhanced value arising out of further planning permission obtained after the exercise of the option. This is particularly useful where the developer obtains successive planning permissions in stages.
The major downside though is that the land owner and developer sit on opposite sides of the option negotiating table and so may be at loggerheads on many terms, including purchase price and level of overage trigger. This adversarial approach could make wrapping up the deal difficult and could even potentially derail the deal altogether. The promotion agreement, with both land owner and developer working on the same side for a common purpose could thus be easier to negotiate and thus wrap up.
Minimising Planning Gain
Under a promotion agreement, both parties are motivated to ensure any planning gain is kept to a minimum. Neither party would want to concede too much to the local planning authority to secure planning permission.
Under an option agreement, if the terms of a Section 106 agreement contribution are too demanding in the eyes of the developer, the developer would not exercise the option – merely incurring the expense of the costs to apply for planning permission and the option fees – effectively sunk costs.
In a conditional purchase contract, the develop would try to classify the planning contribution agreement as an ‘onerous condition’ and get out of completing the purchase contract, since the contract never becomes unconditional. Again, the developer has incurred the sunk costs of applying for planning permission and may have also paid a non-refundable deposit.
Upfront Deposit Payment
Under a promotion agreement, the developer promoter can avoid having to pay the option fee or non-refundable deposit – a nice perk for sitting on the same side of the negotiating table as the land owner. It would however be common for the developer promoter to pay for the land owner’s legal costs when the promotion agreement is entered into – this is similar to option agreement transactions.
The main risks that a developer promoter absorbs are the costs and inability to obtain planning permission and an inability to arrange the sale of the land.
Stamp Duty Land Tax
A ‘bare’ land promotion agreement does NOT give rise to Stamp Duty Land Tax (hoorah!). In reality, most promotion agreements are not ‘bare’ agreements and may be subject to Stamp Duty Land Tax, depending on how the transaction is structured, especially if it is caught by Section 44A of the Finance Act 2003. Careful diligent advice is thus required to ensure the promotion agreement is structured correctly to legally avoid SDLT or if SDLT is unavoidable due to the structure of the agreement, then that cost is factored into the agreement between the parties.