An option contract, or simply option, is defined as "a promise which meets the requirements for the formation of a

contract A contract is a legally enforceable agreement between two or more parties that creates, defines, and governs mutual rights and obligations between them. A contract typically involves the transfer of goods, services, money, or a promise to tr ...

and limits the promisor's power to revoke an offer". Option contracts are common in

professional sport In professional sports, as opposed to amateur sports, participants receive payment for their performance. Professionalism in sport has come to the fore through a combination of developments. Mass media and increased leisure have brought larg ...

s. An option contract is a type of contract that protects an offeree from an offeror's ability to revoke their offer to engage in a contract. Under the common law,

consideration Consideration is a concept of English common law and is a necessity for simple contracts but not for special contracts (contracts by deed). The concept has been adopted by other common law jurisdictions. The court in '' Currie v Misa'' declar ...

for the option contract is required as it is still a form of contract, cf. Restatement (Second) of Contracts § 87(1). Typically, an offeree can provide consideration for the option contract by paying money for the contract or by providing value in some other form such as by rendering other performance or forbearance. Courts will generally try to find consideration if there are any grounds for doing so. See

for more information. The

Uniform Commercial Code The Uniform Commercial Code (UCC), first published in 1952, is one of a number of Uniform Acts that have been established as law with the goal of harmonizing the laws of sales and other commercial transactions across the United States through U ...

(UCC) has eliminated a need for consideration for firm offers between

merchant A merchant is a person who trades in commodities produced by other people, especially one who trades with foreign countries. Historically, a merchant is anyone who is involved in business or trade. Merchants have operated for as long as indust ...

s in some limited circumstances.

Introduction

An option is the right to convey a piece of

property Property is a system of rights that gives people legal control of valuable things, and also refers to the valuable things themselves. Depending on the nature of the property, an owner of property may have the right to consume, alter, share, r ...

. The person granting the option is called the ''optionor'' (or more usually, the ''grantor'') and the person who has the benefit of the option is called the ''optionee'' (or more usually, the ''beneficiary''). Because options amount to dispositions of future property, in

common law In law, common law (also known as judicial precedent, judge-made law, or case law) is the body of law created by judges and similar quasi-judicial tribunals by virtue of being stated in written opinions."The common law is not a brooding omniprese ...

countries they are normally subject to the

rule against perpetuities The rule against perpetuities is a legal rule in the American common law that prevents people from using legal instruments (usually a deed or a will) to exert control over the ownership of private property for a time long beyond the lives of p ...

and must be exercised within the time limits prescribed by law. In relation to certain types of asset (principally

land Land, also known as dry land, ground, or earth, is the solid terrestrial surface of the planet Earth that is not submerged by the ocean or other bodies of water. It makes up 29% of Earth's surface and includes the continents and various isla ...

), in many countries an option must be registered in order to be binding on a third party.

Application of option contract in unilateral contracts

The option contract provides an important role in

unilateral contract A contract is a legally enforceable agreement between two or more parties that creates, defines, and governs mutual rights and obligations between them. A contract typically involves the transfer of goods, services, money, or a promise to tr ...

s. In unilateral contracts, the promisor seeks acceptance by performance from the promisee. In this scenario, the classical contract view was that a contract was not formed until the performance that the promisor seeks was ''completely'' performed. This was because the consideration for the contract was the performance of the promisee. Once the promisee performed completely, consideration was satisfied and a contract was formed and only the promisor was bound to his promise. A problem arose with unilateral contracts because of the late formation of the contract. With classical unilateral contracts, a promisor can revoke his offer for the contract at any point prior to the promisee's complete performance. So, if a promisee provides 99% of the performance sought, the promisor could then revoke without any remedy for the promisee. The promisor had maximum protection and the promisee had maximum risk in this scenario. The modern view of how option contracts apply now provides some security to the promisee in the above scenario. Essentially, once a promisee begins performance, an option contract is implicitly created between the promisor and the promisee. The promisor impliedly promises ''not'' to revoke the offer and the promisee impliedly promises to furnish complete performance, but as the name suggests, the promisee still retains the "option" of not completing performance. The consideration for this option contract is discussed in comment d of the above cited section. Basically, the consideration is provided by the promisee's beginning of performance.

Case law Case law, also used interchangeably with common law, is law that is based on precedents, that is the judicial decisions from previous cases, rather than law based on constitutions, statutes, or regulations. Case law uses the detailed facts of ...

differs from jurisdiction to jurisdiction, but an option contract can either be implicitly created instantaneously at the beginning of performance (the Restatement view) or after some "substantial performance". ''Cook v. Coldwell Banker/Frank Laiben Realty Co.'', 967 S.W.2d 654 (Mo. App. 1998). It has been hypothesized that option contracts could help allow free market roads to be constructed without resorting to

eminent domain Eminent domain (United States, Philippines), land acquisition (India, Malaysia, Singapore), compulsory purchase/acquisition (Australia, New Zealand, Ireland, United Kingdom), resumption (Hong Kong, Uganda), resumption/compulsory acquisition (Austr ...

, as the road company could make option contracts with many landowners, and eventually consummate the purchase of parcels comprising the contiguous route needed to build the road.

Assignability

It is a general principle of contract law that an offer cannot be assigned by the recipient of the offer to another party. However, an option contract can be sold (unless it provides otherwise), allowing the buyer of the option to step into the shoes of the original offeree and accept the offer to which the option pertains.

Contract theory

In economics, option contracts play an important role in the field of

contract theory From a legal point of view, a contract is an institutional arrangement for the way in which resources flow, which defines the various relationships between the parties to a transaction or limits the rights and obligations of the parties. From an ...

. In particular, Oliver Hart (1995, p. 90) has shown that option contracts can mitigate the

hold-up problem In economics, the hold-up problem is central to the theory of incomplete contracts, and shows the difficulty in writing complete contracts. A hold-up problem arises when two factors are present: #Parties to a future transaction must make noncon ...

(an underinvestment problem that occurs when the exact level of investment cannot be contractually specified). However, there is a debate in contract theory whether option contracts are still useful when the contractual parties cannot rule out future renegotiations. As has been pointed out by Tirole (1999), this debate is at the center of the discussions about the foundations of the

incomplete contracts In economic theory, the field of contract theory can be subdivided in the theory of complete contracts and the theory of incomplete contracts. In contract law, an incomplete contract is one that is defective or uncertain in a material respect. A c ...

theory. In a laboratory experiment, Hoppe and Schmitz (2011) have confirmed that non-renegotiable option contracts can indeed solve the hold-up problem. Moreover, it turns out that option contracts are still useful even when renegotiation cannot be ruled out. The latter observation can be explained by Hart and Moore’s (2008) idea that an important role of contracts is to serve as reference points.

References

{{Reflist Contract law

Introduction

Application of option contract in unilateral contracts

Assignability

Contract theory

See also

References