When A Lease Option Comes To An End

Question: Two years ago, when we were having difficulty selling our house, we entered into a lease option. Our prospective purchaser agreed to move in, pay rent for two years, and then have the right to buy the property at the end of that term. It now appears our buyer will be unable to carry through with his option. What happens if the buyer is unable to buy? Does he lose the deposit and the lease payments?

Answer: That is a very good question. It highlights some of the most important elements in all real estate transactions — that all terms should be negotiated in advance, and then reduced to writing.

You have entered into a lease with an option to purchase and your purchaser is to exercise that option within two years of the date of the transaction. If you — or your lawyer — were on the ball when you first entered into the transaction, you would have covered these points in the contract (lease). I assume you have a written lease with an option, and that all of the important terms were spelled out in that document.

If I am a seller who enters into a lease option, I would want a sizeable down-payment, and a monthly rental income which would not be credited for the purchase price. In the event my tenant did not go to final settlement, my preference would be to declare the entire deposit to be forfeited in my favor. The theory behind this strategy is that I am taking my house off the market for a period of time, and I am contracting to sell my house in the future at today’s prices.

On the other hand, if I were the tenant who enters into such a lease option, I would, of course, want different terms. I would attempt to negotiate that all or part of the monthly rental payments would be credited toward the purchase price. Also, if I were unable to go final settlement at the expiration of the lease, I would not want to lose any of my deposit.

Needless to say, you will need good negotiating skills, and the final agreement should be spelled out in writing, and signed by all parties. This is a legal document, and since your tenant will be living in the house for a period of time in accordance with the terms of this document, it should be carefully considered before you enter into the arrangement.

In the absence of language covering the situation you have raised, I suspect that unless you can reach an amicable resolution, you both may end up in court. The seller will take the position that the deposit is forfeited; the tenant will no doubt take the position that the deposit was merely a security deposit for the rental arrangement.

I suspect, however, that if the transaction is in fact a lease with an option to purchase, the court will side with the seller.

You may also want to consider adding the following language to any such leaseoption arrangement:

“Any dispute arising out of this agreement will be decided by an arbitrator, in accordance with the rules of the American Arbitration Association.”

If a dispute does arise, and if you have an arbitration clause, the matter will probably be resolved more quickly — and less costly — than if you have to go to court. However, I want to make it clear that this is not a blanket endorsement of arbitration. There are many situation where, in my opinion, litigation is in the best interests of at least one of the parties.