A contract is an oral or written agreement between two or more parties that creates mutual legal obligations between the parties. There are some contracts that must be in writing to be enforceable, such as those that involve a monetary amount over $500.
What is an Option Contract?
An option contract is a contract to purchase rights at a certain time for a stated price. An option may be contained in a more general contract. It may also be formed as a separate agreement. An option contract is a contract that permits the parties to enter into another contract in the future.
An option contract may cover a wide variety of subject matters. For example, an option may provide a party the right to renew a contract. An option may also involve the right to purchase property.
Option agreements are governed by contract law. They are legally enforceable as long as they follow the requirements for a valid contract. Contract laws vary by state and by subject matter of the contract.
How is an Option Contract Created?
An option contract is created by the following steps:
- A party makes an offer;
- The party agrees that the offer will be open for a specified period of time;
- There is valid consideration to create the option. This may include a deposit to keep the offer open without fear of modification, revocation, or loss to another buyer.
What are Some Common Examples of Option Contracts?
A lease option contract in a real estate transaction is the most common form of an option contract. This type of agreement permits an individual to rent a residential property, such as a house, and then purchase the house once the lease expires. The party renting a property is granted the option of purchasing the house or renewing the lease. The owner is typically prohibited from selling the property during the lease term.
Two common examples of option contracts are an option to renew a contract and an option to keep an offer open. Many contracts contain an option to renew the contract. Options to renew are common in cases where services are rendered in a periodic manner, including yearly subscriptions or athletic employment contracts. In some cases, the purchasing party is required to pay for the renewal.
An option to keep an offer open is sometimes available in the sale of goods. The selling party may accept money to keep the offer open. For example, if an individual has offered to sell their car for $1,000 and accepts a $100 deposit from the buyer on Monday to keep the deal open until Friday, an option contract was formed. The seller is then obliged to keep the deal for $1,000 open until Friday. If the seller sells the car to another buyer before Friday, they may be in breach of contract.
What Does it Mean to “Exercise” an Option?
In an option, one party purchases rights that will be available at a later point in time in the future. Once that point in time arrives, a party may then exercise the option, or claim the rights provided in the option. For example, in a lease option, the individual renting the property may exercise their option to purchase the property once the lease term is completed.
In order for a party to exercise an option, they must usually give a formal notice in writing that they will be exercising their option. If there are any remaining outstanding payments, they should be provided along with the written statement.
What if an Option is not Exercised within the Required Time Frame?
A written option contract will usually provide a timeframe from when the option can be exercised as well as a deadline for when it must be exercised. If the option is not exercised within the provided time period, the purchasing party will forfeit their rights to the option. At that point, the party will not be able to claim their option rights. The party will likely not be able to recover payments made on the option.
If, however, a party has property exercised their option and the selling party refuses to transfer the property or services, the selling party may be held liable for damages pursuant to contract law. Since an option is a contract, it is legally enforceable and subject to remedies for breach of contract.
Can an Option Contract be Breached?
Yes, since, as noted above, an option is a contract and subject to contract laws, it may be breached. There are several ways a breach may occur:
- A material breach;
- A minor breach;
- An anticipatory breach; or
- An actual breach.
A material breach, also called a major breach, occurs when a party to the contract is provided with something significantly different than what was contracted. In most cases, the non-breaching party is not required to perform their portion of the contract. They may also have the right to seek a remedy from the party that breached.
A minor breach, also called a partial breach, occurs when a party fails to perform a portion of the contract, even though the specific service or item was delivered. For example, if a contractor was supposed to complete a home remodel by a certain date but did not complete it until the following day, that would be considered a minor breach.
Anticipatory Repudiation, also known as anticipatory breach of contract, occurs when one party, prior to their required time to perform under the contract, states that they do not intend to perform under the terms of the contract.
An actual breach occurs when one party fails to perform according to the terms of the contract. An actual breach may also occur when one party performs incompletely.
What Remedies are Available for Breach of an Option Contract?
There are two main categories of remedies an individual may seek for breach of contract, damages and equitable remedies. Damages include monetary awards. An equitable remedy may be awarded when monetary damages would be insufficient to properly remedy the plaintiff.
The most common damages award in a breach of contract case is compensatory damages. These damages award the non-breaching party monetary compensation for the breach. They are awarded in an attempt to make the injured party whole.
A contract may include terms for liquidated damages. These damages are a consequence for failure to carry out the terms of the contract. They are generally included in a contract when damages would be too difficult to quantify in the event of a breach. A court will not award liquidated damages if the amount is improper.
Equitable remedies may also be available in cases of contract breach when monetary compensation is not adequate. These may include:
- Specific performance;
- Contract reformation; or
- Contract rescission.
If a court orders specific performance, a party may be required to perform an act or refrain from performing an act. In the case of specific goods, the party may be required to make and deliver the specific goods to the non-breaching party.
Contract reformation occurs if the original contract failed to reflect the parties’ true intentions. This usually occurs when there are mutual mistakes between the parties. The contract will be rewritten to reflect the true intentions of the parties.
Contract rescission occurs when a court cancels, or rescinds, the contract. If the parties desire, a new contract can be created in place of the original contract. This remedy is often awarded in cases of fraud.
Do I Need a Lawyer for Option Contracts?
Yes, it is important to have an experienced contract lawyer assist you with any option contract issues. Like any regular contract, it is best when a contract option is drafted or reviewed by an attorney. Although an option may be agreed upon orally, it is best to memorialize the contract in writing in order to avoid future misunderstandings. A contract lawyer can review or draft an option contract and represent you during any court proceedings, if necessary.