Tuesday, 26 March 2013

Call options over land are well understood commercially but the legal effect of the documents is the subject of controversy and clear drafting is crucial.



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Australia: Call Option Nominations - Poor Drafting Can Hurt

27 February 2013
Article by Gary Chiert


Call options over land are well understood commercially but the legal effect of the documents is the subject of controversy and clear drafting is crucial.
This is not just a theoretical issue. Of particular significance is the flexible mechanism by which a nominee can be appointed to exercise an option. Drafting impacts whether a nominee is duly appointed and in what capacity the nominee acts, namely: as principal or agent.
Unclear drafting can also have adverse stamp duty consequences, as emphasised by the decision of Gzell J in CTI Joint Venture Company Pty Ltd v. Chief Commissioner of State Revenue [2013] NSWSC 20. The case involved the appointment of a nominee under a call option over land in New South Wales.
Nomination provisions have a number of commercial advantages. For example:
  • There may be advantages in a particular company or trustee in a corporate group owning the relevant land, but there is insufficient time to decide on this before the option is granted. In some cases it may be advantageous to use a special purpose vehicle that has not yet been incorporated or established at the time the option is granted. These challenges are characteristic of tight commercial time-frames.
  • A grantee may have entered into the option to develop the land but wishes to take the opportunity to get value for an option in the money without having to take on any development risk.
  • The grantee may be in financial distress and must get value for the option either to pay its debts or because it is no longer viable for the grantee to purchase the land.
The ability to nominate another entity to exercise an option provides a practical and flexible solution. It is therefore important from the grantee's perspective to have a nomination mechanic. The challenge is in determining how the nomination provision should be drafted.
Also, the drafting of the nomination provision is not the end of the matter. If a grantee decides to appoint a nominee, the circumstances and drafting of any arrangement between the grantee and nominee may also trigger a stamp duty liability.
Relevantly, the key stamp duty drafting issues for options over land in New South Wales are as follows:
Transaction Duty drafting questions
Grant Is the option drafted as a conditional contract for sale?
Is the option drafted as an irrevocable offer?
Nomination if there is no put option Is the nomination under the option an assignment or novation?
Is the arrangement between the grantee and nominee an assignment of the option?
Nomination if there is also a put option in place Generally dutiable – both on the option and the market value of the land
There is a clear intention in the duties legislation in New South Wales to charge duty on a nomination under a call option if there is also a put option in place. The opportunity for drafting is key in where there is only a call option.
In the CTI Joint Venture Company case, the Court had to decide whether a nomination was an assignment or novation of the option. If it was an assignment of the option it was liable to transfer duty (the top marginal rate is 5.5%). The issue was not academic because it was apparent that the option had value – the nomination fee was in the order of $60 million. The taxpayer won that case, but the Court had to undertake an arduous and detailed review of the documents because there was no clear statement on either the nature of the option or the character of the nomination.
The option is not the only document that needs to be considered to determine whether duty is payable. The drafting of any agreement between the grantee and nominee is also key. This is because, even if the nomination provisions in the option indicate a novation, any documents entered into between the grantee and nominee may constitute an assignment of the option. For example, if the grantee and nominee enter into an agreement to assign the option to, as well as nominate the nominee then duty will be payable.
In light of the above, the drafting of an option and nomination documents should address clearly:
  • whether the option is an irrevocable offer and to whom that offer is made. An offer can be made to a single person or to a number or class of persons. Whether an offer is made to a single person or a number of persons impacts on the nature of a nomination under the option;
  • the character of the nomination in the option and nomination documents. Are they to be assignments, novations or an acceptance by the nominee of an offer to it; and
  • the character of any agreement between the grantee and the nominee. If the agreement assigns the option then duty will be payable.
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.