singh181 wrote:1. merger agreement is signed that contains the provision for penalties.
2. merger agreement that contains the provision for penalties is signed.

a. 1 is correct
b. 2 is correct
c. both are correct
d. neither is correct

Please choose one and provide some explanation.

2 is preferable, as a relative clause should ideally be as close as possible to the noun it modifies/describes. A typical sentence structure can withstand some distance between the main subject and main verb, but is less tolerable of the same distance between a noun and it's modifier. So all other things being equal, 2 is the better sentence.

However, I remember the line from an official question (can't find it now, but I'm sure it's been posted in these forums), and if memory serves, the correct answer uses version (1). I can't remember whether (2) was an option or not, but if the question included an answer that uses (2), I'd look very carefully to see whether that answer choice has any other issues that prevent it from being the right answer.

Hello,

Thanks a lot for your reply. I was understanding different ways in which a construcion can be correct. I found that sentence from this GMATPrep questions:

Not one of the potential investors is expected to make an offer to buy First Interstate Bank until a merger agreement is signed that includes a provision for penalties if the deal were not to be concluded.

Both are correct. However, the modifier is correctly placed in OPTION 2
BUT option 1 is correct because it brings a small part before a long modifier.
You may want to refer WHEN NOUN MODIFIER DON'T FOLLOW TOUCH RULE topic in MGMAT SC

Thanks