Option Money: What's the Big Deal?

Fri, 02/14/2020 - 10:32am

OPTION MONEY: What is it? 

Option money is a very important piece of a buyer’s contract.  When a buyer pays an option fee they are purchasing the unrestricted right to cancel the contract in the time provided for in the contract.  This timeline is intended to be used for buyer due diligence and if the buyer finds something that causes them to want to cancel the contract they can do so for any reason as long as the termination is done timely.

Let’s closely examine the contractual language of Paragraph 23 to discuss some key points: 

23. TERMINATION OPTION: For nominal consideration, the receipt of which is hereby acknowledged by Seller, and Buyer’s agreement to pay Seller $_____________ (Option Fee) within 3 days after the Effective Date of this contract, Seller grants Buyer the unrestricted right to terminate this contract by giving notice of termination to Seller within ____________ days after the Effective Date of this contract (Option Period). 

The key points to take from this sentence: 

  1. The fee must be delivered within 3 days of the effective date.  If funds are delivered late there is no option under the contract; 
  2. The sentence obligates the buyer to pay this fee to the seller.  It may also be delivered to the listing agent or broker as the seller’s representative; 
  3. An unrestricted right to cancel until the prescribed timeline is conditioned upon payment of the option fee. 

Notices under this paragraph must be given by 5:00 p.m. (local time where the Property is located) by the date specified. 

Historically there was great debate on what time of day the option period ended.  Some argued that it was 5:00pm local time and some argued that it was midnight.  Thankfully the Texas Real Estate Commission (“TREC”) has now clarified that a buyer must notify the seller of their contract termination by 5:00pm local time for notice to be effective.  

If no dollar amount is stated as the Option Fee or if Buyer fails to pay the Option Fee to Seller within the time prescribed, this paragraph will not be a part of this contract and Buyer shall not have the unrestricted right to terminate this contract. 

This sentence is important as it makes it clear that the option is only available under the contract with proper payment of the fee.  Without proper payment, the buyer does not have the unrestricted right to cancel.  

If Buyer gives notice of termination within the time prescribed, the Option Fee will not be refunded; however, any earnest money will be refunded to Buyer. The Option Fee ___ will ____ will not be credited to the Sales Price at closing. 

This sentence controls whether or not the buyer gets the option money credited back at closing.  Typically we see it credited back but a real estate agent should be careful to mark the correct box to document the terms that were negotiated.  

Time is of the essence for this paragraph and strict compliance with the time for performance is required.

This is where we get into the important legalese of this paragraph.  Any time a contract includes the language “strict compliance” it means that all of the words must be followed exactly to perform under the contract.  It means the parties to the contract need to do exactly what the paragraph says and not deviate from those instructions.  

OPTION MONEY: Frequently asked questions? 
Q: Can option money be delivered to the seller via electronic payment (i.e. Venmo, Paypal, etc.)
A: Yes, as long as that payment is unconditional payment.  If your client is out of town this is a great option.  In a pinch, you could also ask your title company to prepare a Federal Express air bill to send the option money directly from the buyer to the seller. 

Q: We signed our contract on Thursday.  When is the option money due? 
A: The option money would be due Sunday (you count Friday, Saturday and Sunday).  It is important to note that this paragraph does not provide an extension if the deadline lands on a weekend or holiday.  If the due date is a Sunday, that is the deadline for delivery.  

Q: Who signs the Option Fee Receipt on page 10 of the contract? 
A: The seller or listing representative/broker receipts this section of the contract.  It is not receipted by anyone else in the transaction.  
Q: Can option money be delivered to the title company? 
A: This is a trickier one.  If the question is “can” it be delivered to the title company the answer is “yes” --- but that answer is not one without some liability for the buyer’s agent delivering that option money.  The language in the contract does not provide for delivery of the option money to the title company.  It requires delivery to the seller so while a title company accepts option money (and then turns around and sends it to the seller) that is not complete delivery of the option fee under the contract.  

If this scenario were put to the legal test, delivery of option to the title company is not “strict compliance” with the contract and an agent could be creating liability for themselves.  Both TREC and the Texas Association of Realtors have highlighted the point that buyer’s agents are expected to deliver the option money to the seller or seller’s agent.  If you are considering delivering option money to the title company our best suggestion is that you talk this over with your broker before taking that action.   

Q: What could happen if there is a defect in the option fee delivery process? 
A: If the option fee is not properly handled then you could wind up with your buyer not actually having an option period under the contract.  


LET’S LOOK AT A FEW SCENARIOS: 
Scenario One: A contract is signed late Friday.  The buyer’s agent meets with her client to pick up earnest and option money on Saturday.  When the title company opens on Monday she brings the earnest money and option money to the title company with a message that the listing agent is going to pick up the option fee.  The listing agent is busy and is not able to get to the title company to pick up the check but goes to the title company on Tuesday to pick up the check.
Does this buyer have an option period? The buyer does not have an option because the money was not delivered until the 4th day after contract and strict compliance is required with the contract.  

How could this have been handled differently? Delivered the option money directly to the seller or seller’s agent on or before Monday.  


Scenario Two: A contract is signed Tuesday and the next morning the buyer brings the earnest money and the option money to the title company.  The title company, as a courtesy, delivers the option money to the seller via courier that same day.  

Does this buyer have an option period? Technically no because the money was delivered to the title company and not the seller.  A savvy seller would be able to say that the contract was not strictly complied with so the option period was not created.  So……what if the buyer wants to terminate under the option period now? They probably do not have the legal right to terminate and keep their earnest money.  Without the option, any termination not otherwise provided for in the contract would be a forfeiture of the earnest money.   

AGENTS: PROTECT YOURSELF AND YOUR CLIENT

When acting as a buyer’s agent a real estate agent should always insist that the option money is delivered directly to the listing agent or the seller and that it is delivered within 3 days of execution of the contract.  Properly setting up the option period under the contract is an expected duty of the real estate agent as a fiduciary to the client and agents are responsible for taking the appropriate steps to create the option.  It is important to note that if an agent is the proximate cause of the client losing money (i.e. buyer terminates and loses their earnest money because the option was not properly handled) a remedy that TREC has ordered is to require that the real estate agent personally refund the buyer for their forfeited earnest money.