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Question. Eighteen months ago, when we were having great difficulty selling our house, we entered into a lease option. Our prospective purchaser agreed to move in, pay rent for 18 months and then have the right to buy the property at the end of that term.

It now appears our buyer will not be able to carry through with his option. What happens then? Does the buyer lose the deposit and the lease payments?

Answer. That is a good question. It highlights one of the most important elements in all real estate transactions -- all terms should be negotiated in advance, and then put into a written document, signed by all parties.

You have entered into a lease with an option to purchase and your buyer is to exercise that option within 18 months of the date of the transaction. If you or your lawyer were on the ball when you entered into the agreement, you would have covered these points in the contract (lease). I assume you did enter into a written lease with an option, and that all of the important terms were spelled out in that document.

As a seller who enters into a lease option, I would want a sizable down payment and a monthly rental income that would not be credited for the purchase price. In the event my tenant did not go to 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.

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

You will need good negotiating skills to get a document favorable under your terms. Of course, market and financial conditions will play a significant role in how the agreement will end up. Since your tenant will be living in your house for a period of time in accordance with the terms of the agreement, it should be carefully considered before you sign it.

In the absence of language covering the situation you have described, I suspect that unless you can reach an amicable resolution, you may both end up in court. You probably will take the position that the deposit is forfeited; the tenant will no doubt contend that the money 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 lease-option 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 you have an arbitration clause and a dispute does arise, the matter will probably be resolved more quickly -- and typically less expensive -- than if you have to go to court. However, a lot of attorneys (myself included) prefer litigation. A Judge -- rather than an arbitrator -- will analyze the facts and apply applicable law. From my experience, many arbitrators just "split the baby in half".

But whether you go to court or arbitration, here's another clause to be included in the agreement: "The Court (or the Arbitrator) will award legal fees and costs to the prevailing party." Here in the United States, we follow what is known as the "American Rule on Legal Fees". Each side pays its own lawyer unless there is a statute (such as the consumer protection laws) or a provision in a real estate contract that gives the winning party legal fees. In England, the winner gets her legal fees paid.

So, in your case, to make sure the American Rule will not apply, put that language in your written agreement.

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