Posted by Peter Foskett, Partner
What’s best for landowners? A promotion or option agreement – it’s just like apples and pears
A question frequently asked by landowners is what is the difference between an option agreement and a promotion agreement? And which should they enter into?
It is partly like deciding whether to eat an apple or a pear – they have similarities and differences.
In their simplest forms, under a promotion agreement, a promoter obtains planning permission for development of the landowner’s land, which is then sold and the promoter shares in the sale proceeds.
Under an option agreement a developer obtains planning permission for development of the landowner’s land and then has the exclusive right to purchase the land at a price below its open market value. In each case the landowner will not reimburse the promoter or developer for the cost of applying for planning permission if no planning permission is granted.
There is no simple answer in deciding which approach to pursue however a landowner should keep the following issues in mind:
• Promotion agreements have often reflected a longer-term approach to achieving development of land which is currently unlikely to secure planning. This is increasingly less so.
• A promotion agreement usually envisages the development site being quite substantial in size. Where the land to be developed is small in area then an option agreement would normally be used, as potential promoters will generally not find the risk/reward ratio to be high enough.
• One of the objectives of a promotion agreement is to sell the land once planning has been obtained. There is therefore a greater certainty of achieving a sale. Under an option agreement, the developer can choose not to buy the land having obtaining planning. Commercially this is unlikely given the costs which will have been incurred to obtain planning. Should it happen, it would leave the landowner with the benefit of planning permission having been obtained. Increasingly though, developers are seeking to put a landowner under an obligation to market and sell the land and then to reimburse the developer the costs it incurred in obtaining the planning permission.
• The objective of a promotion agreement being to sell the land means that the land will be marketed (possibly “off market” but nevertheless there will be more than one potential buyer). There is therefore firstly the opportunity for the value to be increased through competitive offers or by a special purchaser, and secondly the price will not be a technical valuation subject to hypothetical (and possibly disputed) assumptions. In other words, the landowner can be assured that the land has sold for its true open market value. Such reassurance will require the payment of sale commission to the agents that market the land. Conversely surveyor’s fees will be payable in negotiating a hypothetical market value under the terms of an option agreement. At least with the recovery of the market, there is much more open market sales data available where a valuation is required.
• An option agreement usually contains a timetable for the option following the grant of planning permission. The timetable gives the developer some flexibility to try to time the valuation of the land at the time that results in the lowest value. The longer the periods of time in that timetable, the greater scope a developer has to achieve this. Under a promotion agreement (subject to the following point) both parties are aligned in their desire to time a sale to achieve the highest, rather than lowest, price.
• A promoter makes its money by obtaining planning, selling and moving on to the next project. There is therefore a risk that a promoter will choose to sell sooner than later (possibly in conflict to the preference of the landowner), even though a higher price probably could be achieved by waiting a longer period of time to sell. In the case of an option agreement, the developer will certainly choose to buy sooner rather than later if this means it buys at a price lower than if it exercised the option later – in other words, there is no disadvantage to a promotion agreement, rather the possibility of being in a better situation.
• The principle of maximising the profit means that a promoter has a greater incentive to negotiate as low a planning gain contribution as possible. Under an option agreement, this incentive is less where the developer will be able to reduce the price to be paid by the amount of planning gain to be paid (in cash or kind). Indeed a developer may in due course be able to fulfil the planning gain work obligations for less that the amount by which it argues down the purchase price, or even re-negotiate the obligations after buying the land; in each case it will secure a windfall gain for itself.
• A landowner needs to discuss his intentions with his tax advisor before entering into either of these arrangements. Extra special care may need to be taken to ensure that the money received by a landowner under a promotion agreement is not treated as income, rather than a capital receipt. That danger should not apply in the case of an option agreement.
Just to make reaching a conclusion even harder, there is also a hybrid agreement; an option agreement which allows the developer to elect to market the land for sale to a third party, i.e. effectively to turn it into a promotion agreement at the end.
The general view is that the interests of the landowner and promoter under a promotion agreement are more closely aligned with the intent of maximising value than they are under an option agreement, where the developer wishes to purchase the land for as low a figure as it can. Nevertheless, conflicting interests still remain between a landowner and a promoter with regard to the costs incurred by the promoter in the process of obtaining planning permission and to a lesser extent, how quickly the land is sold after planning permission is obtained.
Whichever agreement is chosen, a landowner needs to take advice and carefully consider the tax position. If a promotion agreement is chosen, there are two immediate concerns. Firstly, that the promoter will be required to charge VAT on all payments it receives (i.e. reimbursement of its promotion and planning costs AND its percentage share in the resulting net proceeds of sale); secondly the landowner and promoter are at risk of being treated as being in partnership and taxed as such.
Contact our Commercial Property team for more information on promotion or option agreements and any other commercial development issues.
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