Freezer clauses in Options – landowner’s guide
I’m increasingly seeing, when negotiating and drafting option agreements over land, a new clause finding its way into the drafting, which reflects, perhaps, a growing concern amongst developers that the housing market is heading for a decline.
An option agreement will often see the purchase price calculated by reference to a percentage of the open market value of the land at the point that planning permission is obtained. So, for example, a landowner might expect to receive 85% of the open market value of the land, with the benefit of planning permission. What constitutes “open market value” is a rich source of argument, with one party seeking to erode and the other to shore up the calculation of this figure.
In order to guard against erosion, landowners will often seek to agree that a minimum price provision is incorporated into the option agreement. This will set a threshold for the purchase price below which the landowner is not obligated to sell. It’s in options containing such provisions that the “freezer clause” is beginning to make its appearance.
The freezer clause typically comes into operation where the purchase price, as calculated by reference to the option, does not exceed the minimum price because of a downturn in the housing market, which depresses the calculation of market value. In such circumstances the option period (i.e. the timescale the developer has within which to elect to purchase the land) will “freeze” until such period as the purchase price crosses the minimum price threshold.
The developer seeks to justify the inclusion of such a clause by arguing that, having expended considerable sums on acquiring planning consent, it should have the opportunity, where a minimum price cannot be met, to “sit out” any period of market downturn and then acquire at, or above, that figure when the market recovers.
This isn’t, in and of itself, an argument that should be rejected out of hand by a landowner given that such an agreement would be in the interests, in theory at least, of both parties. There are, however, points for the well-advised landowner to consider:
- A freezer clause should be tied only to a market downturn that deflates the purchase price to below the minimum price. If the developer has failed to achieve minimum price through poor analysis of cost, for example, then they should be forced to make the decision between paying a minimum price or else potentially seeing the landowner terminate the option agreement and re-contract elsewhere. Freezer clauses should not become negotiation levers for the developer to mitigate failings on its part under the option. The obtaining of planning permission should remain at the developer’s risk.
- The landowner will need to give thought to their inheritance tax planning, in the context of a freezer period. The land will, during a freezer period, be consented and its value will have therefore increased. In the event of the death of the landowner during that period this will result in, potentially, a large increase in inheritance tax payable. Detailed tax advice should be taken by any landowner, prior to entering into an option agreement and the potential risks created by freezer clauses should be specifically discussed and mitigated against as part of that process.
- A further concern for landowners should be the possibility of a future government introducing legislation that seeks to tax landowners who hold consented development land that is not being actively developed. In Wales we await the introduction of the Vacant Land Tax, which may see development sites taxed following the Irish model. Would land being held subject to a freezer clause trigger such a tax and, if so, can the landowner meet a tax that, in Ireland falls between 3 and 7% of the land value?
- There is also a question as to whether landowners themselves should be looking to introduce freezer clauses into options for their own benefit, where future governments have brought in more punitive tax rates on the sale of development land. My instinct here is that this will not find traction in the market. No developer is likely to want to see themselves prevented from realising the fruits of their labour in this way, not least where it is open to the landowner, at the point of negotiation of the option, to begin their tax planning, should they be concerned at such an eventuality. Freezer clauses, I suspect, will be one-way traffic from the developer’s side, in all but rare cases.
It occurs to me that there are a number of possible ways to address risk, including the landowner being able to sell at a reduced value at any point during the option period (thereby enabling an “exit” from the land). Alternatively, could the developer be asked to offer an indemnity against any tax, where they elect to trigger a freezer clause? I struggle to see how this can be made palatable for the developer other than, perhaps, where the originally negotiated heads of terms take into effect this possibility and where the commercially agreed terms reflect it.
Option agreements are very much documents of the future, seeking to regulate the conclusion of agreement many years after they are exchanged. The challenge facing lawyers advising clients currently is that the future legislative landscape in which such agreements will reach fruition is extremely hard to read, not merely in the context of Brexit but the potential political upheaval that will almost certainly follow that event. Freezer clauses within options, although relatively innocuous in and of themselves, give rise to much wider considerations that have to be carefully considered and weighted by clients as they look to enter into agreements that might substantially increase the value of their land and their personal wealth in years ahead.
James Davies is a real estate partner at RDP Law, who specialises in the acquisition, assembly and sale of development land.