Contracts: Key differences between options, preferences and rights of pre-emption

Introduction

ContractsCommon contractual clauses include those of Options, Preferences or Rights of Pre-Emptions. These are particularly common in contracts of sale as well as contracts of lease in some cases. While all these instruments have the effect of benefiting one of the parties to a contract, there are a number of key differences.

All of the above are known as pactum contrahendi or a contract in which the parties undertake to contract further. Thus, there is essentially a principal obligation or contract such as a sale, and then a secondary, ancillary contract or obligation. Our courts have established that pactum contrahendi in general must comply with any other formalities required by legislation, for example, that all sales of immovable property must be in writing. Generally used in contracts of sale, all of these can prove to be valuable commercial instruments as shall be illustrated. This article will discuss each of these instruments and their operation in further detail.

Option

 An Option is essentially where the person making the offer, undertakes not to withdraw the offer and is forced to keep it open. Thus, an offer and its terms are made irrevocable. This can be extremely valuable from a commercial perspective, especially in markets where prices and demand fluctuate. Our courts have held that an Option may only be created by agreement between the parties and may not be created unilaterally. Further, an Option is distinct from a situation where an offer is made which must be accepted within a fixed period. An Option and the rights attached thereto can also be bought and sold, making it commercially valuable. To illustrate, a farmer, A offers to sell one ton of grain to B at a market related price per ton in January and includes an option. While by December, the price of grain may have increased, B will still be entitled to buy it at the same price and on the same terms.

Right of Pre-Emption/Preference

A Right of Pre-Emption, also known as a Preference can be described as a Right of First Refusal. As the name Preference implies, this means that the seller in terms of a contract such as a sale, must approach the preference holder first, should he or she elect to sell. In contrast to an option, it is not as strong a Right, as the purchaser’s Right only comes into existence by way of a trigger event -normally the seller’s election to sell. Whereas with an Option, the seller may exercise their Right when it suits them. An example of a preference or right of preemption, specifically in the context of a lease, is where A leases a property to B and grants B a preference. Should B elect to sell, he would have to offer it to B first.

Conclusion

 In conclusion, both Options and Preferences are valuable commercial contractual instruments if used correctly, especially where one seeks to secure the ability to buy something back in the future or in volatile sector such as agriculture.It is strongly advisable to reduce both the principle contract such as the sale as well as the secondary agreement to writing and have it signed and dated by both parties to avoid any confusion as to the record of offer and acceptance.

Contact SchoemanLaw Inc for all your contractual and drafting needs.

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