But It’s "Just" An Option! Option Risks And The Tale Of Horn v. Xylem

November 15, 2023

Written By Craig Garbe, Dana Talucci and Jane Helmstadter

We all take real property purchase agreements seriously. We read only the title and we know that a transaction is likely to occur, perhaps a significant one. We can also reasonably expect that there will be a property, a price, a timeline, probably some representations and warranties, and perhaps conditions to be satisfied. But an "option" to purchase a property? Well, that just doesn't sound quite as important now does it? After all, if something is optional it might not even be needed, or it might never exist. It certainly doesn't seem to warrant as much attention as an agreement to purchase—so perhaps no great amount of attention should be paid to it?

Of course not.

The problem is, options rarely get the attention they deserve. Too often an option enters a transaction late in the day, perhaps as a conciliation for another concession or in an attempt to appease a party who isn't quite ready to commit. They are often shoehorned into other documents, tacked on as a schedule or scratched out in broad strokes with details to be filled in if and when the right is exercised. This is all risky business.  An option to purchase land creates an equitable (and registrable) interest in that land, and the exercise of (and perhaps existence of) an option is really only possible if all of the contractual terms that would typically be found in a purchase agreement are known. Parties will typically turn their minds to the price payable for the exercise of an option (though we have even seen prices missing from some), but what about the rest? Condition of the land, termination of tenancies, discharge of mortgages or other encumbrances, timelines for closing, diligence periods, representations and warranties, indemnities, adjustments and readjustments… the list is long. And these are just the provisions typical for a purchase agreement—what about the terms and conditions of the option itself? Sadly, those too are often hastily considered and drafted, leading to costly litigation, as the decision in Horn Ventures International Inc. v. Xylem Canada LP¹ reveals.

To begin, a brief review of the decision. 

An Ongoing Dispute

The dispute between Xylem and Horn had been ongoing for some time, with this latest decision being the fourth in a series of two lawsuits, the initial decision of each of which was brought to the court of appeal. The dispute centered around what was (importantly) referred to as Horn's "obligation" to purchase land that it was leasing from Xylem, once certain conditions were met. The land in question was heavily contaminated, and though Horn had agreed to lease the land from Xylem, Xylem was obligated to remediate the contamination and had broad access rights to enable it to do so. The lease provided that Horn would be obligated to purchase the land once: (a) Xylem had "completed the Remediation"; and (b) Xylem had provided a certificate from an environmental consultant about the sufficiency of the remediation. Horn argued: that condition (a) was one and the same as condition (b); that since it had a right to waive (b) it could waive (a); and that if condition (a) was distinct it benefitted only Horn and so Horn was entitled to waive it. None of these arguments were accepted. The application and appeal judges held that condition (a) was distinct from (b) and that it benefitted both parties (since Xylem could be held liable for contaminated land it once owned even after the sale and hence had an interest in remediation). They also noted that to permit Horn to waive the condition (a) would effectively give Horn an option to purchase the land at any time, which was inconsistent with Xylem's negotiated rights to access the land to remediate and with the classification of this as an "obligation" to purchase, not an option.

First, what did Xylem and Horn do correctly? They scheduled a copy of the purchase agreement to the agreement containing the option: excellent. The decisions don't contain a full copy of the purchase agreement, but we know that it set out the price for the asset, some representations and warranties, and some closing deliveries—presumably it would have worked well as a basis to complete the sale.

Who Triggered the Option and When?

The problem for Xylem and Horn was the determination of when the option was triggered and by whom. And it isn't hard to see why.  We have mentioned conditions (a) and (b) as though these were clearly drafted preconditions, but on the language of the contract things were muddier.  The full text of the provision provides:

The Landlord and the Tenant agree that the Tenant shall have the obligation to purchase the Premises upon the following terms:

(a) The Landlord shall advise the Tenant that the Landlord has completed the Remediation and shall provide an unqualified and unconditional certificate from an environmental consultant, both of which certificate and consultant must be satisfactory to the Tenant in its sole and unfettered discretion, addressed to both the Landlord and the Tenant and upon which both the Landlord and the Tenant may in law rely upon, confirming that any and all environmental problems at the Premises (save and except those caused by the Tenant) have been successfully remediated in accordance with the then current guidelines of the [Ministry of the Environment and Energy] or any other governmental agency having jurisdiction over the matter and in accordance with any applicable laws, rules or regulations and in accordance with the then best recognized practice. The said certificate shall further confirm, without qualification or condition, that the then current environmental condition of the Premises does not then exceed or violate in any way the then current guidelines of the [Ministry of the Environment and Energy] or any other governmental agency having jurisdiction over the matter or any applicable laws, rules or regulations (save and except for any environmental problems caused by the Tenant). The foregoing requirement for delivery of the said certificate is inserted for the sole benefit of the Tenant and may be waived by the Tenant at any time by written notice delivered by the Tenant to the Landlord.

(b) Within twenty (20) business days of either receipt by the Tenant of the certificate referred to in paragraph 11(a) or receipt by the Landlord of the waiver referred to in paragraph 11(a), the Tenant shall deliver an executed copy of the agreement of purchase and sale in the form of the agreement and [sic, of] purchase and sale (the "Agreement of Purchase and Sale") attached hereto as Schedule "D", together with the required deposit cheque. Upon delivery of the Agreement of Purchase and Sale to the Landlord, the Agreement of Purchase and Sale shall be firm and binding and shall be completed in accordance with the terms thereof. [emphasis added]

On a first read, the agreement seems to support Horn's position that it should be able to waive delivery of the environmental certificate and complete the sale. After all, that right to waive is clearly set out at the bottom of paragraph 11(a), and the rest of that paragraph (as well as some of 11(b)) focuses on the sufficiency and substance of the certificate. But it is the underlined words at the top of the clause that the court (rightfully, in our view) focused on. When taken in the context of the broader agreement, which made it clear that Xylem was to remediate the property, that such remediation couldn't be guaranteed, and that Xylem could access the property to do so, those words were interpreted to create a clear condition (in both parties' favour) that the remediation must have been completed before the right to purchase crystallized—that is to say that an obligation to purchase arose, not an option, once Xylem had done its part. Horn could not waive these conditions and exercise its option, it didn't ever have one. Rather, it had an obligation to purchase once Xylem had completed the remediation.

Of course we cannot say with certainty when the parties developed their competing interpretations of the contract.  Perhaps they were never really in agreement about the terms, though perhaps more likely is that Horn only sought a more generous interpretation of the contract once the land had significantly appreciated in value and there was money to be made through compelling Xylem to complete the transfer. What we can say with certainty is that different drafting could have eliminated some of the doubt. Preconditions to an obligation (or option) to sell should always be clearly drafted in favour of one or more parties to the agreement, indicating who benefits from such condition and who (if any) may waive such condition. Clear contractual provisions surrounding preconditions to an obligation (or option) also mitigate against the risk that a court will interpret a condition to be a 'true condition precedent': a condition that is dependent on a future uncertain event controlled by a third party which and which neither party can waive unilaterally. True conditions precedent, if found to exist and to not have been satisfied, will terminate a contract regardless of one party's attempts to waive them. If, however, the parties have turned their minds to such future events and specifically crafted rules for those scenarios, the courts are less likely to overrule contractual provisions that give waiver rights to a single party. In a purchase agreement these conditions and the rules surrounding them typically take up significant space and attention—the same must be true of any option (or future obligation) agreement, perhaps even more so. Option agreements, or conditional future purchase agreements (as this was), by their nature tend to exist and operate for a longer duration than the average purchase agreement, so acute attention to timelines, to waiver rights in respect of conditions, and to possible intervening circumstances, is critical. 

Timelines in Option Agreements

Timelines are important not only for the commercial agreement, but also to ensure the enforceability of the option a law. When creating option agreements for real property (or conditional future purchase agreements, as in this case), the parties must ensure that the conditions tied to the contingent interest in land will be satisfied (and, accordingly, that the interest in land will vest) within the applicable limitation period, since the common law and statutory 'rule against perpetuities' in Ontario voids any contingent interest in land which does not vest prior to the end of a perpetuity period. The perpetuity period is a the duration of a "life in being" plus twenty-one years from the date that the interest in the land was created, and a "life in being" is a life which, at the time the interest was created, limits or is a relevant factor that limits in some way the period within which the conditions for vesting of the interest may occur. Typically the 'life in being' concept is more relevant in the case of testamentary dispositions; for example, a gift of a property stated to occur to someone following the death of another person would be valid, but the 21 year period would begin at the end of the that person's life, so if the gift was to occur 22 years following such person's life it would be void. If the vesting period is not limited by a life in being (as is the case in most commercial transactions), then the perpetuity period is simply twenty-one years from the date that the interest in the land was created. While more often considered in cases of testamentary disposition, the rule against perpetuities is alive and well and applies to commercial real property transactions, as was made clear in the court of appeal's recent decision Ottawa (City) v. ClubLink Corporation ULC.² And, while it applies generally to all contingent interests in land, it is typically more relevant during the creation of option agreements where there is more likely to be an extended contingency period. 

In this case, there was no outside date set for Xylem to complete the remediation (though the lease term could potentially have ended the conditional obligation), and so if Xylem had not completed the required remediation and triggered Horn's obligation to buy within 21 years from the lease date, it may have been open to either party to argue that the obligation to purchase was void. We also don't know if Horn and Xylem considered this rule when creating their agreement, but the rule could have been an important factor in the analysis had a little more time elapsed, as it was for ClubLink.

Guarding Against Risks

An option to purchase real property can be a powerful transactional tool to allow parties to reach a business agreement that might not otherwise be possible. They are not, however, simple creatures, and should always be given due consideration. An option agreement typically carries with it all of the risks and issues of a typical real property transaction, as well as those additional risks and issues that arise where a significant amount of time elapses between the date of the agreement and the ultimate land transfer. As time passes and parties' intentions change, the importance of a properly drafted option agreement that properly contemplates potential future scenarios, as well as guards against potential future transaction risks, becomes ever more important.

Please contact the authors of this blog for more information on the issues discussed in this post, or for assistance as you look to identify and implement transactions of this nature.

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