During the course of researching this book, I found no court cases nationwide in which a residential lender has exercised its loan's due-on-sale clause and declared a loan to be in default upon discovering that the borrower had created and sold a straight or naked real estate option on the property securing the mortgage or deed of trust and promissory note.
The due on sale clauses included in almost all commercial mortgage or
deed of trust loans do not specifically prohibit the creation and sale of a
straight or naked real estate option on the property securing the mortgage or
deed of trust and promissory note. The fact is that other than governmentbacked
multifamily loans, most commercial mortgage or deed of trust loans are
one of a kind loan instruments written specifically for the property securing
the loan and almost never contain any prohibition against creating and selling
a real estate option.
Real Estate Options and the
Doctrine of Equitable Conversion
Under what is known as the doctrine of equitable conversion, once a real estate
purchase agreement is signed by all parties and becomes effective, the buyer becomes
the equitable owner and the seller retains bare legal title to the property
under agreement. However, under a real estate option, the equitable conversion
does not occur until after the option is exercised and not when the real estate option
agreement is signed by all parties and becomes effective.
This is because there is no legal obligation to buy and sell until after a real estate option is exercised.
After a real estate option is exercised, the optionee buyer retains equitable
ownership of the property.
The difference between a real estate option agreement and a standard purchase
agreement is that there is no contractual obligation to purchase the property.
For example, when a buyer and seller sign a purchase agreement, they
become legally obligated to buy and sell the property under contract, and either
party can be sued if he or she fails to do so.
However, when an optionee and optionor sign a real estate option agreement, the optionee has no contractual obligation
to purchase the property under option. An optionee can let a real estate
option expire, and an optionor has no legal recourse against the optionee.
Why a Straight Real Estate Option
Agreement Is Not an Executory Contract
An executory contract is generally defined as: "a contract where both parties have
an obligation to perform in the future". And state and federal courts nationwide
have traditionally held the view that straight or naked real estate options are unilateral
contracts, under which the obligation to perform rests solely on the optionor,
while the optionee is under no obligation to do anything whatsoever.
The only notable exception to this is when an option agreement is included in a federal
bankruptcy petition and the optionee has notified the optionor of his or her
intention to exercise the option prior to the bankruptcy petition being filed.
The Seven Key Elements of a
Real Estate Option Transaction
A real estate option transaction consists of the following seven key elements:
1. Optionee: Optionee is the party buying a real estate option. Once a real estate
option is exercised, the optionee becomes the buyer.
2. Optionor: Optionor is the party selling a real estate option. Once a real estate
option is exercised, the optionor becomes the seller.
3. Real estate option: When an optionee buys a real estate option, he or she
buys an exclusive, unrestricted, and irrevocable right and option to purchase
a property at a fixed purchase price within a specified option period.
4. Option consideration: Option consideration is the amount of money paid by
an optionee to buy a real estate option from an optionor.
5. Option period: The option period is the specific period of time stated in the
real estate option agreement in which the option is in effect.
6. Exercise of option: The exercising of a real estate option occurs when the optionee
notifies the optionor, in writing, that he or she is going to exercise
the real estate option and purchase the property under option.
7. Expiration of option: A real estate option expires when an optionee fails to
exercise his or her real estate option within the option period stated in the
real estate option agreement.