A contract is an oral or written agreement between two or more parties that creates mutual legal obligations between the parties. To be valid and enforceable, a contract must include:
- An offer
- An acceptance of the offer presented
- A promise on each side to perform their contractual duties
- A valuable consideration from each party (“consideration” means something that each party will give up or do. For example, in a contract to buy a car, the buyer’s consideration is the money for the car, and the seller’s consideration is turning over ownership of the car)
The majority of contracts are governed by statutes of the state in which they are made. Therefore, it is important to consider local laws when dealing with a contract issue. An attorney will know the local laws and how they apply to a contract.
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 or as a separate agreement.
An option contract may cover a wide variety of subject matters. For example, an option may provide a party the right to renew the 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.
Details of contract laws vary by state and subject matter of the contract.
What are Some Common Examples of Option Contracts?
The most common form of an option contract is a lease option contract. This type of agreement allows an individual to rent a residential property, such as a house, and then have the option to purchase the house once the lease expires. The owner is typically prohibited from selling the property during the lease term.
Another very common type of option is a stock option. An employer often offers its employees stock options in the employer company as an incentive to work for them. Typically, stock options become available to an employee after working at the company for a certain amount of time. At that time, the employer will sell shares of the company stock to the employee for less than the market value of that stock.
The employee may then sell the shares of the stock on the stock market for more money than was spent by the employee purchasing the stock. This allows the employee to make money off their shares of the stock.
Two more 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 periodically, including yearly subscriptions such as gym 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 selling 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 is 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 will 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 time arrives, a party may then “exercise” the option, meaning claim the rights provided in the option. For example, in a lease option, the individual renting the property may exercise their option to purchase it.
For a party to exercise an option, they must usually give a formal written notice that they will be exercising their option. If there are any remaining outstanding payments (such as rent payments), they should be provided along with the written statement.
What if an Option is not Exercised within the Required Time Frame?
An option contract will usually provide a date establishing when the option can first be exercised, as well as a deadline by which it must be exercised. If the option is not exercised within the provided period, the purchasing party will forfeit their rights to the option. If the party has made payments toward the option, it is unlikely that they will be able to recover them.
If, however, a party has properly exercised their option and the selling party refuses to transfer the property or services, the selling party may be held liable for damages according 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?
An option is a contract, and like any contract, it may be breached. There are several ways a breach may occur:
- A material breach
- A minor breach
- An anticipatory breach
- 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. For example, a contractor had a deadline for completing a home remodel, but on that date, they had finished only ⅓ of the project. In most cases, the non-breaching party is no longer required to perform their portion of the contract. They may also have the right to seek a remedy from the breached party.
A minor breach, or partial breach, occurs when a party fails to perform just a portion of the contract. For example, if a contractor were 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, or anticipatory breach of contract, occurs when one party states that they do not intend to perform their contractual obligations. This happens before the date the project was supposed to be delivered, which is why it is called an “anticipatory” breach).
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 categories of remedies an individual may seek for breach of any contract: damages and equitable remedies. Damages include monetary awards. An equitable remedy may be awarded when monetary damages would be insufficient to properly put the plaintiff back into the position they were in before signing the contract.
The most common damages award in a breach of contract case is compensatory damages. These damages award the non-breaching party monetary compensation for any money they lost or had to pay due to the breach. The amount of the damages to be paid may be up to the trial judge, or there may be a term in the contract for “liquidated damages.” These damages are generally included in a contract when damages would be too difficult to quantify in the event of a breach.
Equitable remedies may also be available in cases of contract breach when monetary compensation is not adequate. These may include:
- Specific performance
- Contract reformation
- Contract rescission
If a court orders specific performance, a party may be required to perform its contractual obligations even though they don’t want to, or they may be ordered to do something or to refrain from doing something that the court believes will put the non-breaching party in the position they would have been in had the breach not occurred.
Contract reformation occurs if the original contract fails to reflect the parties’ true intentions. This usually occurs when the contract isn’t clear about something, and so the contract does not reflect the parties’ actual intentions. An example would be if the contract required product delivery to “Springfield,” but did not state whether that meant Springfield, Illinois, or Springfield, Ohio. 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 an option contract is drafted or reviewed by an attorney to make certain that it reflects your true intentions and understanding of what each party’s obligations are. Although an option may be agreed upon orally, it is best to memorialize the contract in writing to avoid future misunderstandings. A contract lawyer can review or draft an option contract and can also represent you during any court proceedings, if necessary.
