Editing Option contract

{{Short description|Type of contractual promise}}
{{Globalize|article|USA|2name=the United States|date=December 2014}}
{{Contract law}}
An '''option contract''', or simply '''option''', is defined as "a promise which meets the requirements for the formation of a [[contract]] and limits the promisor's power to revoke an offer".<ref>''[[Restatement (Second) of Contracts]]'' § 25 (1981)</ref> Option contracts are common in relation to property (see [[#Introduction|below]]) and in [[professional sport]]s.

An option contract is a type of contract that protects an offeree from an offeror's ability to [[Revocation|revoke]] their offer to engage in a contract.

Under the common law, [[consideration]] 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.<ref>"Examples and Explanations for Contracts, 7e", Brian Blum, 2017 p. 104 [p. 109 in PDF version]. Wolters Kluwer.</ref> See [[consideration]] for more information. The [[Uniform Commercial Code]] (UCC) has eliminated a need for consideration for [[firm offer]]s between [[merchant]]s in some limited circumstances.<ref>{{cite web|url=https://www.law.cornell.edu/ucc/2/article2.htm#s2-205 |title=Uniform Commercial Code - § 2-205. Firm Offers|website=Cornell University Law School, Legal Information Institute}}</ref>

==Introduction==
An option is the right to convey a piece of [[property]]. The person granting the option is called the ''optionor''<ref>{{Cite web|url=http://dictionary.findlaw.com/definition/optionor.html|title=Optionor}}</ref> (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]] countries they are normally subject to the [[rule against perpetuities]] and must be exercised within the time limits prescribed by law.

In relation to certain types of asset (principally [[Real property|land]]), 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]]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.<ref>See § 45 of [[Restatement (Second) of Contracts]] for the [[black letter law]] of the option contract's application to this situation.</ref> 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]] 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). Case law in [[England and Wales]] has established that in exercising an option, a grantee "must comply strictly with the conditions for its exercise".<ref>[[Frederick Lawton (judge)|Lawton, LJ]], [https://www.bailii.org/ew/cases/EWCA/Civ/1973/5.html Holwell Securities v Hughes <nowiki>[</nowiki>1973<nowiki>]</nowiki> EWCA Civ 5], [[England and Wales Court of Appeal]] (Civil Division), delivered 5 November 1973, quoting from ''Hare v. Nicholl'', 1966 2 Queens Bench, 130, accessed 8 September 2023</ref>

It has been hypothesized that option contracts could help allow [[free market road]]s to be constructed without resorting to [[eminent domain]], 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.<ref>{{cite book|title=Street Smart: Competition, Entrepreneurship, and the Future of Roads|chapter=Do Holdout Problems Justify Compulsory Right-of-Way Purchase|author=Benson, Bruce L.|year=2006|page=65}}</ref>

==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.<ref>John D. Calamari, Joseph M. Perillo, ''The Law of Contracts'' (1998), p. 707.</ref>

== Contract theory ==
In economics, option contracts play an important role in the field of [[contract theory]]. In particular, [[Oliver Hart (economist)|Oliver Hart]] (1995, p. 90) has shown that option contracts can mitigate the [[hold-up problem]] (an underinvestment problem that occurs when the exact level of investment cannot be contractually specified).<ref>{{Cite book|title=Firms, contracts, and financial structure|last=Hart|first=Oliver|publisher=Clarendon Press|year=1995}}</ref> However, there is a debate in contract theory whether option contracts are still useful when the contractual parties cannot rule out future renegotiations.<ref>{{Cite journal|last1=Lyon|first1=T. P.|last2=Rasmusen|first2=E.|date=2004|title=Buyer-Option Contracts Restored: Renegotiation, Inefficient Threats, and the Hold-Up Problem|journal=Journal of Law, Economics, and Organization|language=en|volume=20|issue=1|pages=148–169|doi=10.1093/jleo/ewh027|issn=8756-6222|url=http://kelley.iu.edu/riharbau/RePEc/iuk/wpaper/bepp2004-10-lyon-rasmusen.pdf}}</ref> As has been pointed out by Tirole (1999), this debate is at the center of the discussions about the foundations of the [[incomplete contracts]] theory.<ref>{{Cite journal|last=Tirole|first=Jean|date=1999|title=Incomplete Contracts: Where do We Stand?|journal=Econometrica|language=en|volume=67|issue=4|pages=741–781|doi=10.1111/1468-0262.00052|issn=1468-0262|citeseerx=10.1.1.465.9450}}</ref> In a laboratory experiment, Hoppe and Schmitz (2011) have confirmed that non-renegotiable option contracts can indeed solve the hold-up problem.<ref>{{Cite journal|last1=Hoppe|first1=Eva I.|last2=Schmitz|first2=Patrick W.|date=2011|title=Can contracts solve the hold-up problem? Experimental evidence|journal=Games and Economic Behavior|volume=73|issue=1|pages=186–199|doi=10.1016/j.geb.2010.12.002|s2cid=7430522}}</ref> 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.<ref>{{Cite journal|last1=Hart|first1=Oliver|last2=Moore|first2=John|date=2008|title=Contracts as Reference Points*|journal=Quarterly Journal of Economics|language=en|volume=123|issue=1|pages=1–48|doi=10.1162/qjec.2008.123.1.1|issn=0033-5533|citeseerx=10.1.1.486.3894}}</ref> 

== See also ==
* [[Firm offer]]
* [[Offer and acceptance]]

==References==
{{Reflist}}

[[Category:Contract law]]