An Option to Purchase (“OTP”) is a document commonly used in property transactions to set out the terms on which a vendor agrees to give a purchaser the opportunity to purchase a property. It generally identifies the property, states the agreed purchase price and sets out the conditions that must be fulfilled for the transaction to proceed.
An OTP will usually contain several important terms that both the vendor and purchaser should understand before signing.
Purchase Price and Earnest Deposit
The OTP will normally state the agreed purchase price of the property. It may also provide for the payment of an earnest deposit, which is a sum of money paid by the purchaser to the seller.
Depending on the terms of the OTP, the earnest deposit may form part of the purchase price or the deposit payable under the eventual Sale and Purchase Agreement (“SPA”). The OTP should clearly state the amount payable and how the earnest deposit will be dealt with if the transaction proceeds or falls through.
Booking Form
In some property transactions, a purchaser may first sign a booking form and pay a booking fee before the OTP or SPA is entered into. The booking form may record basic details such as the property, purchase price and amount paid.
A purchaser should not assume that a booking form and an OTP have the same legal effect. The wording of the particular document and the intention of the parties are important in determining whether a binding agreement has been created.
Vendor’s Default
The OTP will commonly contain provisions dealing with what happens if the vendor fails to proceed with the transaction. Depending on the terms agreed, the purchaser may be entitled to a refund of the deposit and, in some circumstances, may have additional contractual remedies. The OTP should therefore clearly state the consequences of the vendor’s failure to complete the transaction.
For example:
– The vendor fails to proceed with the sale and must refund the earnest deposit to the purchaser.
– The vendor breaches the OTP, and the purchaser may be entitled to claim compensation, depending on the terms of the OTP.
– The purchaser may have other contractual remedies available under the OTP.
Purchaser’s Default
The OTP may also provide for the consequences if the purchaser fails to proceed with the purchase. Depending on the terms of the OTP, the vendor may be entitled to forfeit the earnest deposit or exercise other contractual rights. The terms dealing with default, forfeiture and refunds should therefore be carefully reviewed before an OTP is signed.
For example:
– The purchaser fails to sign the SPA within the stipulated period.
-The purchaser fails to pay the required amount within the agreed timeframe.
– The purchaser decides not to proceed with the purchase, resulting in the earnest deposit being forfeited, depending on the terms of the OTP.
When Does an OTP Become Binding?
An Option to Purchase (“OTP”) is commonly used at the early stage of a property transaction, before the formal Sale and Purchase Agreement (“SPA”) is prepared and signed. It may set out important terms such as the purchase price, earnest deposit and the period within which the purchaser is required to proceed with the purchase.
OTP will normally states that the transaction is “subject to contract” or “subject to a formal SPA being drawn up and signed.”
Whether the OTP is binding will depend on whether the parties intended to be bound by the OTP or only after the formal SPA is signed.
As the legal effect of an OTP can vary depending on its wording and circumstances, it is advisable to engage a solicitor to review the OTP before signing or paying any deposit. This can help you understand your rights and obligations and avoid misunderstandings before proceeding with the transaction.
The following are some key matters to consider when determining whether an OTP has created a binding contract.
When May an OTP Not Be Binding?
An OTP does not necessarily create a binding contract simply because it has been signed. Whether the parties are legally bound will depend on the wording of the OTP, the terms agreed and the parties’ intention.
In Sejati Education Sdn Bhd v S3M Development (Sabah) Sdn Bhd [2015], the court considered an option to purchase property and the circumstances in which an option may become enforceable. The case highlights the importance of examining the terms of the option and the parties’ conduct in determining whether contractual obligations have arisen.
Similarly, in Eng Song Aluminium Industries Sdn Bhd v Keat Siong Property Sdn Bhd [2018] MLJU 421, the parties’ correspondence stated that the transaction was “subject to contract” and that there would be no binding agreement until the formal agreements were executed. The court considered the wording used by the parties and the surrounding circumstances in determining whether a concluded contract had been formed.
But Does “Subject to Contract” Always Mean the OTP Is Not Binding?
Not necessarily.
In RHB Trustees Bhd v Always Ahead (M) Sdn Bhd [2024] 11 MLJ 896, the Letter of Offer for the sale of a property was also expressed to be “Subject to Contract”. However, the court found that a binding contract had been formed after considering the terms of the Letter of Offer and the parties’ subsequent conduct.
These cases show that the words “Subject to Contract” should not be considered in isolation. The court will look at the wording of the OTP, the terms already agreed, the surrounding circumstances and the parties’ conduct to determine whether the parties intended to be legally bound.
For purchasers and vendors, it is therefore important to understand whether the OTP is intended to create immediate contractual obligations or whether the parties intend to be bound only after a formal SPA is agreed and signed. The terms of the OTP should be carefully reviewed before it is signed.
Why Should You Care?
For a purchaser or vendor, this distinction is important because you may not always be free to walk away simply because the formal SPA has not yet been signed.
Before signing or accepting an OTP, it is therefore important to understand:
– whether the OTP itself is intended to be binding;
– what happens to the deposit if either party defaults;
– whether there are conditions that must first be fulfilled; and
– whether the eventual SPA is intended to create the contract or merely formalise an agreement already reached.
A short phrase such as “subject to contract” may therefore have important consequences. The legal effect will ultimately depend on the wording of the OTP and the intention of the parties.
Understand the Documents Provided by the Property Agent
When dealing with a property agent, you may be asked to sign documents such as a viewing acknowledgement, offer to purchase or booking form. Do not assume these are merely “standard forms”, as they may contain important terms on the purchase price, deposit or other obligations.
For example, in a subsale transaction, you may be asked to sign an offer or booking document and pay an earnest deposit before the SPA is prepared. For transactions such as a transfer by way of love and affection, different documents and requirements may apply.
These documents do not replace the SPA or other formal legal documents, and their legal effect depends on their wording and the circumstances. Before signing or paying any money, make sure you understand what you are agreeing to and seek legal advice if necessary.
Remember: A registered estate agency negotiator (REN) acts under the supervision of the registered estate agency. You may ask for the agency’s details and verify the REN’s registration with the Board of Valuers, Appraisers, Estate Agents and Property Managers (LPPEH).
Buying Directly from the Owner
If you are purchasing a property directly from the owner without involving a property agent, it is advisable to engage your own solicitor at an early stage.
Where an Option to Purchase (“OTP”) or similar offer document is proposed, your solicitor can prepare or review the document before you sign it or pay an earnest deposit.
An OTP can set out important terms such as the purchase price, deposit, period for completing the purchase and any conditions that must be satisfied. Depending on its wording and the circumstances, signing such a document may have legal consequences.
Having your solicitor involved from the outset can help ensure that the agreed terms are properly recorded and that relevant legal checks are carried out before you become committed to the transaction.
Buying your first home is a significant commitment. If you are considering a property purchase and require assistance with the OTP, SPA, searches or conveyancing process, contact us to find out how our firm can assist you.