Despite years of common law case law analyzing the issue of whether an enforceable option has been entered into, even today courts struggle with the issue. Few cases illustrate the difficulties surrounding whether a binding option exists better than Steiner v. Thexton (2010) 48 Cal.4th 411. Steiner is a recent California Supreme Court case concerning an option to purchase roughly 12 acres of raw land. The case arose in a far different economic climate, and because the seller intended to pursue a deal with better terms with another buyer.
Initially the seller had received two offers to purchase the property. One of the offers was for $250,000 more than Steiner's offer, but required that the seller procure the approval and permits to develop the property. The seller however opted to accept Steiner's offer.
Steiner's offer was to acquire the property for $500,000 by September 2006 if he elected to purchase the property after pursuing county approvals and permits at his expense. Significantly, the option agreement provided that Steiner could cancel the transaction at any time at his "absolute and sole discretion."
After carrying out the entitlement work and incurring the associated costs of roughly $60,000, the seller decided to terminate the agreement, and sale the property for a higher price. Steiner filed suit.
Originally the trial court ruled against Steiner. The trial court held that the option agreement was unenforceable, because it was not supported by consideration. Consideration is the bargained for exchange that is necessary to make a contract enforceable. This may come in the form of giving something to another, or incurring a detriment based on the agreement. The trial court found that Steiner did not tender any consideration, because the option could be terminated for any reason whatsoever. Then on appeal, the appellate court upheld the decision. The ruling was again based on a decision that Steiner's obligation to develop the property was illusory at the time the option was entered into, because Steiner could terminate the agreement for any reason.
The California Supreme Court overturned the decision. First, the court ruled that at the time the option was entered into it was in fact an illusory obligation. Thus, at that time the option was not binding. However, after Steiner relied on the option agreement by incurring the costs of developing the property, it was then supported by consideration. Steiner's part performance "cured the illusory nature of their promise". Id. at 422.
There is a debate among real estate lawyers as to how the Steiner decision has impacted the commonly used residential purchase agreement in California. Some attorneys believe that the decision supports the method set forth in the standard California Association of Realtors's purchase agreement. Others believe that one of the two central holdings renders each CAR agreement an unenforceable option agreement.
First, CAR purchase agreements are different than the option at issue in Steiner. CAR's purchase agreements are bilateral agreements that include contingencies. If the contingency fails then the buyer is permitted to withdraw from the contract. Nevertheless, the issue centers on the holding that at the time that the option agreement was entered into in Steiner the Court held it was an unenforceable option. That is, at that time the option was not supported by consideration.
Under the standard CAR form the buyer makes an offer, tenders a refundable deposit, and then has certain contingencies. The CAR's position is that this is a binding bilateral agreement with conditions, and therefore not an option agreement. This is a position supported in a side comment by the Court in Steiner. Id. at 419.
Even so, some attorney's still believe the CAR contract runs afoul of the option agreement in Steiner. For example, one of the conditions in the standard CAR contract is the buyer's inspection contingency. Along with that right the CAR form includes an addendum entitled Buyer's Inspection Advisory, which states that the buyer should look into any issue that he or she may find personally to be a concern. Taken together, some contend that this right to not waive an inspection contingency is very much like Steiner's escape clause. Stated simply, the buyer in a CAR contract has no obligation to do anything and can simply not waive the inspection contingency and then receive a full refund of the deposit.
CAR's position on this is that there is an implied covenant of good faith in each and every agreement. As a result, a buyer must act honestly in refusing to not release a contingency. In fact, CAR has just amended its agreements to state explicitly that a buyer must invoke a contingency or cancel the agreement must be done in good faith. Further, a deposit is tendered and so the buyer is giving up the right to use that money while it is held in escrow. Notably, in footnote 12 of Steiner the Court punted on deciding whether Steiner's deposition of $1,000 was sufficient consideration even though it was refundable at Steiner's sole discretion. Id. at 422.
These issues are and the other provisions found in the newly revised CAR form are sure to be an issue in the future. It is therefore critical that any party faced with this issue retain an attorney well versed with the CAR form and these issues.
In the commercial context almost all buyers will only enter into an option agreement if they have a right to terminate the agreement for any reason.
In the commercial context, the ruling that the option as it existed at the time it was entered is an illusory obligation, is an issue that should be a concern. This is because it is common practice in a commercial option that the buyer will tender a refundable deposit. Once again, the Steiner opinion does not provide a clear rule to the parties with respect to whether refundable deposits constitute sufficient consideration. Specifically, under footnote 12 the court expressly avoided making any ruling on whether tendering a refundable deposit will be sufficient, and avoided the issue altogether in the context presented by Steiner. Id. at 422.
If you will recall Steiner had deposited $1,000 for slightly more than one year. Of course, it is also a difficult issue to draft a provision for or predict, because under Steiner the court must analyze whether any detriment has been incurred at the time one party attempts to terminate an option agreement.
Therefore, when looking to draft an enforceable option it is important to confer a benefit or clear detriment without giving up too much. The first option and one sellers will like to see is a sizable deposit. The second issue, however, is whether the deposit should be refundable and to what degree. There is older California case law providing that a relatively nominal and nonrefundable deposit is sufficient consideration. Even so, there is always the question of whether it is enough.
The third option is to simply pay a fee, and lastly a set list of mandatory due diligence that the buyer must perform. The most important issue for due diligence items is to explicitly set forth the inspections or other due diligence that the buyer must perform. This is not too great a burden for the buyer because usually the buyer is going to do the inspections regardless. Finally, the option should include language expressly memorializing the benefits exchanged between the parties.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.