The Legality of Sandwich Lease Options
Many real estate gurus erroneously teach their students to acquire control with a Lease with Option and then “resell” the property to a tenant-buyer with another Lease with Option. The problem is that the student in the middle of the sandwich has NO EQUITABLE INTEREST in the real property, and therefore cannot grant an option to buy the real property. An unexercised option contract has no equitable interest in the subject asset, as concluded by many court cases, including the US Bankruptcy Court.
This is a consequence of the Doctrine of Equitable Conversion. The unexercised option is merely a contract that compels the Optionor to keep open an offer to sell for a specific price and payment terms for a specific timeframe. When the option is exercised with all contingencies removed or satisfied, then the equitable conversion applies to exchange the seller’s equitable interest in the real property for the buyer’s equitable interest in the notes and good funds as specified in the Purchase and Sale Agreement (PSA), signed and notarized only by the owners of record, that is attached to the option contract. If the Optionee exercises the option (by signing the PSA), and then cannot perform according to the payment terms, then the Optionee is in breach of contract and the Seller or Optionor can sue for damages.
Quoting Wachovia Bank v. Lifetime Industries, (2006) 145 Cal.App.4th 1039, 1050, the court reasoned: “Although an option gives the optionee contractual rights to purchase the property, it is ‘merely an offer to sell and vests no estate in the property to be sold.’” The option holder does not have an “interest” in the land, the court found.
The court went on to say: “An option is transformed into a contract of purchase and sale when there is an unconditional, unqualified acceptance by the optionee of the offer in harmony with the terms of the option and within the time span of the option contract,” quoting Steiner v. Thexton (2010) 48 Cal.4th 411, 420.
Of course, you should record a Memorandum of Option acknowledged (notarized) by all owners of record to protect your contractual interest (not equitable interest) in the pending transaction as providing constructive notice to an “innocent buyer” (3rd party) that may buy the property from the unscrupulous seller without giving notice to you or to that 3rd party buyer.
Therefore, the sandwich lease-option will cause tremendous legal and financial problems for you when the owner or the tenant-buyer files a lawsuit against the you for illegally granting an option to buy an asset that you don’t own. The solution is quite simple: Grant an option to buy an asset that you own, which is your option contract with the seller.
An option to buy an option is an option contract that grants to the Optionee the right to buy the Optionor‘s option contract with the seller. The Optionee notifies the escrow agent when ready to exercise and the escrow agent verifies that the payment terms for the option consideration are satisfied. The Optionee then signs the assignment agreement in the presence of the escrow agent. At exercise, by signing the attached assignment agreement as the Assignee, the Assignee now owns the Option as the Optionee with the seller and can exercise that option, by signing the attached Purchase and Sale Agreement (PSA), to buy the property from the seller. The ConvertLeaseOptionToWrapAround.xlsm spreadsheet includes a Word 2016 mail merge template to grant an option to your buyer to buy your option contract with the seller.