It is well known that when a contract has been terminated due to a serious breach, any deposit paid is forfeited and non-recoverable. This applies across a range of contract types and is commonly seen in the sale of property.
Indeed, many contracts refer to the deposit as ‘non-refundable’ or even as a type of ‘pseudo-security’ for performance of the contract.
In law, however, the reality is less simple than it might appear for deposits on termination of a contract for breach.
In this blog, we look at four key issues relevant to the status of a deposit upon termination of a contract for breach:
- What is the effect of termination upon the obligations of the parties to the contract?
- When is a deposit considered reasonable?
- When will a deposit be forfeited to the vendor and when can a purchaser claim recovery?
- Can there be an alternative claim in damages by the non-breaching party?
1. What is the effect of termination upon the deposit obligations of the parties to the contract?
Firstly, it is important to note the status of any deposit paid prior to the termination of a contract.
Legally, where a contract is terminated for breach, the parties are not returned to the position they were in prior to entry into the contract.
Rather, termination applies from the time that the non-breaching party elects to exercise its right to termination and does not apply retrospectively (see Boston Deep Sea Fishing and Ice Co v Ansell (1888) 39 CH D 339 at 365). Furthermore, the ultimate effect of termination is to remove the need for the parties to be ready and willing to perform their obligations under the contract (see McDonald v Denny Lacselles Ltd (1933) 48 CLR 457, per Dixon J at 476-7).
All this is to say that the election to terminate a contract by the non-breaching party does not of itself require that party to return any deposit already paid by the breaching party.
While a deposit does not need to be returned to effectively terminate a contract, that does not necessarily mean that the breaching party who paid the deposit, in other words the purchaser, will have no claim to the deposit.
Long established legal principle – deposits an ‘earnest of performance’
Ancient law has established the principle which remains today, that a deposit is considered an ‘earnest of performance’ (i.e. showing that the purchaser is earnest in their intention to fulfil their obligations under the contract), or a type of security to fulfil the contract, which is not recoverable (i.e. is forfeit) should the purchaser in fact fail to fulfil their obligations (McDonald).
2. When is a deposit considered reasonable?
It is generally accepted in Australian law that a reasonable deposit is no more than 10% of the purchase price (See, for example, Manufacturers House Pty Limited v Ashington No 147 Pty Limited [2005] NSWSC 767 and Havyn Pty Ltd v Webster [2005] NSWCA ).
Thus it is generally accepted where a deposit represents 10% or less of the purchase price, and this amount has been paid by the purchaser prior to termination, then this amount is forfeited to the vendor, i.e. it cannot be recovered by the purchaser in breach.
This begs the question what happens when a deposit exceeds 10%?
This question is answered by the leading authority of Lord Browne-Wilkinson in Workers Trust and Merchant Bank Limited v Dojap Investments Limited [1993] AC 573, who states at 580 that:
“the customary deposit has been 10 per cent. A vendor who seeks to obtain a larger amount by way of forfeitable deposit must show special circumstances which justify such a deposit.”
What these ‘special circumstances’ entail is dependent on the facts underpinning each contract and its termination, such as whether the deposit has paid upon entry into the contract, whether there is evidence of unconscionable conduct, or whether the deposit had been split into multiple parts.
3. When will a deposit be forfeited to the vendor and when can a purchaser claim recovery?
What is clear is that when a deposit is over 10% of the purchase price, the vendor will need to provide evidence as to why such a deposit is necessary.
If they are unable to do this than the entirety of the deposit, or the amount that exceeds 10%, will be found not to have been a ‘genuine deposit’ and therefore not to have been forfeited by the purchaser to the vendor.
If that is the case, the purchaser make seek to recover the deposit payment from the vendor in a claim in equity or common law.
Inconsistencies of current case law and jurisdictional factors
We note that current case law is inconsistent on whether a deposit in excess of 10% can be split such that the excess only is returned to the purchaser (such as in Manufacturers House) or whether the whole of the deposit paid should be returned (see Sydney Developments Pty Ltd v Perry Properties Pty Ltd [2016] NSWSC 515).
Alongside these principles, different State and Territory laws play a role dependent on the type of contract.
For example, when selling land in NSW, section 55(2A) Conveyancing Act 1919 (NSW) applies to this issue:
(2A) In every case where the court refuses to grant specific performance of a contract, or in any proceeding for the return of a deposit, the court may, if it thinks fit, order the repayment of any deposit with or without interest thereon.
This section empowers the Court to order the return of any sum of money under a deposit, even if it is the customary 10%.
In determining whether to exercise this power, however, the Court in Manufacturers House has said that it will look for some evidence of unconscionable conduct on the vendor’s part, or circumstances surrounding the contract or arising out of the contract, or subsequent events which would justify an order for the return of a deposit of 10%.
4. Can there be an alternative claim in damages by the non-breaching party?
One further consideration to note is that where a ‘deposit’ is found not to be a sum which is protected by ancient law as an ‘earnest of performance’, the vendor may nevertheless be able to claim the deposit as a payment in liquidated damages, being a genuine pre-estimate of the loss which the innocent party will suffer by reasons of the breach, to be assessed by the circumstances at the time of entry into the contract.
Alternatively, the vendor may be able to claim the sum in damages for actual loss arising from the purchaser’s breach, in respect of which proof will be required.
These four factors are important to keep in mind when drafting and entering into contracts, or when electing to terminate a contract.
It is important to consider whether a deposit over 10% of the purchase price is truly necessary and the implications for the deposit should the contract be terminated for breach.
If a deposit is to exceed 10%, it may be wise to split the deposit into two parts, with at least 10% to be paid upon entry into the contract to better protect the vendor’s right to retain that sum should they find it necessary to elect to terminate upon breach by the purchaser.