Accepting payment by instalments on property purchases, also known as a “split deposit”, could mean you can’t enforce payment of the part paid after the date of the contract.
Timing is everything
Part I of this article looked at the recent Supreme Court of NSW case of Alexakis v Wan [2021] NSWSC 367, in which a buyer lost his deposit on the purchase of a property in Vaucluse because he was late in paying the second instalment of the deposit.
In that case, the contract stated the deposit was to be 10% of the purchase price, the buyer only paid 5% and the seller did not seek to claim the balance of the full 10% deposit.
Wasn’t the seller entitled to claim the full 10% deposit?
Although there was no discussion of it in the case, the reason for that may be that recent case law suggests the seller’s prospects of succeeding with such a claim would not have been good.
In Part II of Pitfalls when paying deposits by instalments on property purchases, we review some recent cases and the pitfalls associated with accepting payments by instalments on property purchases from the sellers’ side.
The increasing use of split deposits or instalments on property purchases
In today’s booming property market, it has become increasingly common for property buyers to negotiate payment of a 5% deposit upon exchange of contracts, due to increasingly high property prices and the difficulty in raising a full 10% deposit. Contracts in such purchases usually provide that although a 5% instalment on the property purchase is accepted on entering into the contract, the buyer is still obliged to pay the full 10% on or before settlement.
Frequently the contract will say that the deposit is payable by instalments, with the balance payable on or before settlement (also known as a “split deposit”). Often, contracts state that if the balance remains unpaid, it will be payable as a debt due to the seller if the buyer cannot complete the purchase. Alternatively, contracts state any unpaid portion remains payable as “liquidated damages”, being a genuine pre-estimate of damages, the seller will suffer if the buyer fails to complete the purchase.
The law of penalties applied to instalments on property purchases
The problem sellers face in recovering the unpaid part of a split deposit or instalment on a property purchase is that the courts often find they are not a true deposit, but instead they function as a penalty, which is illegal in a civil contract. As the High Court of Australia said in Ringrow Pty Ltd v BP Australia Pty Ltd [2005] HCA 71; (2005) 224 CLR 656:
“The law of penalties, in its standard application, is attracted where a contract stipulates that on breach the contract-breaker will pay an agreed sum which exceeds what can be regarded as a genuine pre-estimate of the damage likely to be caused by the breach.”
Sellers wanting to recover the unpaid instalment of a split deposit when the sale is terminated due to the buyer’s default may be required to apply to a Court for an order that the buyer must pay it. In doing so, they run the risk that the Court will find they have no right to such an order due to the law of penalties. The courts have wrestled with this issue in a series of cases in recent years concerning cases of instalments on property purchases and the results for sellers have been mixed.
Most recently, the Supreme Court of NSW looked at this question in the case of Blanco v Wan [2021] NSWSC 273, which was decided on 24 March 2021 and serves as a useful reminder of the risk taken by sellers accepting a 5% deposit and hoping to be able to claim the rest later if the sale contract is terminated.
The case of Blanco v Wan
In this case, the buyer of a property in Kingsford for $2,055,000 paid $80,000 of the 10% deposit of $205,500 on exchange of contracts but never paid the balance of $125,500 because the buyer failed to complete the purchase and so the seller terminated the contract. The seller then asked the Court to order the buyer to pay that unpaid balance. The seller was able to re-sell the property to a different buyer for a higher price, so no claim was made for a loss suffered on re-sale.
The first sale contract contained a clause stating that the seller would accept payment of the deposit in instalments of $80,000 on exchange of contracts and the balance payable “on or before settlement”. The clause also provided that if the original buyer defaulted, she would “forfeit the full 10% deposit and the unpaid balance shall become payable immediately upon default to the vendor”.
The Court confirmed that sellers are permitted to recover a reasonable deposit (of no more than 10% of the purchase price) and that the principles concerning penalties and forfeitures do not apply to such stipulations in contracts. However, this only applies in respect of payments that truly have the character of deposits or instalments on a property purchase.
In the case of Blanco v Wan, there was a useful summary of the cases looking at this question. The Court held that in cases like this, when the seller seeks to recover an unpaid instalment due to the default of the buyer, the instalment loses its character as a deposit and becomes a penalty and cannot be recovered.
Instalments on a property purchase – are they a deposit or penalty?
How can you tell whether an instalment payment is a true deposit or a penalty? The case law going back at least 137 years (e.g. Howe v Smith (1884) 27 Ch. D. 89) tells us that a true deposit is provided as “an earnest to bind the bargain”, which means the deposit acts as:
- an indication that the purchaser is serious in carrying out the bargain; and
- a form of security or guarantee for the performance of the buyer’s obligations under the contract.
As the Court confirmed in Blanco v Wan, if a contact says the balance of a “split deposit” or instalments on a property purchase becomes immediately due and payable upon the buyer’s default (e.g. a failure to complete the purchase), such a stipulation is inconsistent with the character of a deposit payment and is in reality an illegal and unenforceable penalty.
The High Court of Australia in the recent case of Paciocco v Australia and New Zealand Banking Group Ltd [2016] HCA 28, discussing the “Dunlop tests” (laid down by the House of Lords in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79), characterised a contractual penalty as an additional detriment imposed on the buyer that is “extravagant, exorbitant, or out of all proportion to the interest sought to be protected”. namely the seller’s interest in the due performance and ultimate completion of the contract. Such a payment is viewed as being punitive in nature, rather than being intended as an earnest to bind the bargain.
This does not mean that a clause permitting payment of instalments on a property purchase or a split deposit will always result in the second instalment payment being unenforceable as a penalty. The Court in Blanco v Wan confirmed that a second instalment payment can be upheld and enforced as long as it can be regarded as an “earnest of performance” rather than a penalty.
A contract provision that requires payment of an agreed sum as a supposedly genuine pre-estimate of damages for breach will be a “penalty” if that agreed sum in fact exceeds what can be regarded as a genuine pre-estimate of the damages likely to be caused by the breach of contract.
Whether it is a penalty will depend on the degree of proportionality between the agreed sum and the likely loss to be suffered and whether the Court determines that the amount is extravagant, exorbitant or unconscionable in comparison to the greatest loss that could be proved, such that its real purpose is to punish or coerce the offending party.
It does not matter that the parties in such cases have chosen to call the instalment payment a “deposit”, if in fact it does not have the character of a deposit for the above reasons.
You win some, you lose some when paying deposits by instalments on property purchases
There have been cases of paying deposits by instalments on property purchases where the seller was allowed to recover a deposit instalment. For example:
- Cloud Top Pty Limited v Toma Services Pty Limited [2008] NSWSC 568: In the “Cloud Top”case, the amounts specified as deposits were held not to be extravagant or unconscionable and did not possess any character of a penalty. The final 5% instalment was payable on the 42nd day after the contract was entered into, whether or not completion of the contracts actually occurred on that date, and did not arise by reason of termination of the contracts.
- Rana v Dalla Costa [2014] NSWSC 1113: In this case the second instalment of the deposit was recoverable on the basis that it was due 140 days before settlement (rather than “on or before settlement”). The Court held that the instalment retained its character as a true deposit, acting as an earnest or guarantee of performance of the contract.
- Sydney Developments Pty Ltd v Perry Properties Pty Ltd [2016] NSWSC 515: A 20% deposit payable in two 10% instalments on a property purchase was held not to be a penalty because it was considered a valid deposit. The second instalment was payable no later than 122 days from the date of the contract (some five months prior to the contractual completion date) and was not a penalty because the amount was not forfeited in the event that the contract was terminated upon breach by the purchaser. However, the Court only permitted 10 per cent of the purchase price to be forfeited in accordance with settled principles and clause 9.1 of the standard contract.
There have also been cases where the seller was not allowed to recover a deposit instalment. For example:
- Luu v Sovereign Developments Pty Ltd [2006] NSWCA 40 and Iannello v Sharpe [2007] NSWCA 61: In these two cases the 10% deposit payable on any default, whether trivial or serious, is punitive and not a genuine deposit or a genuine pre-estimate of damages.
- Boyarsky v Taylor [2008] NSWSC 1415: In this case the second deposit instalment was not “an earnest for performance” because it was exacted on the buyer’s breach of contract and was thus a penalty.
- Kazacos v Shuangling International Development Pty Ltd [2016] NSWSC 1504: In this matter the seller was not entitled to recover the deposit because the 5% second instalment was payable upon the buyer’s default and thus was not “an earnest for performance”.
Commentary on cases of paying deposits by instalments on property purchases
In the Cloud Top case, the 10% deposit was to be paid in 3 instalments, the first (being 1.25%) on exchange of contracts, the second (being 3.75%) 14 days after exchange and the balance (being 5%) to be paid on the “completion date”, which was the 42nd day after the date of the contract. The buyer failed to complete the purchase and did not pay the 5% balance, so the seller sought to recover it. The Court held that the seller was entitled to recover the unpaid 5% instalment because:
- the deposit amount was not extravagant, excessive or unconscionable and did not have the characteristics of a penalty;
- it was significant that payment of the 5% balance was not to occur on the completion of the contracts, but rather on the “completion date”, i.e. on the 42nd day after the contracts were made whether or not completion of the contracts actually occurred on that date; and
- the obligation to pay the 5% balance of the deposit did not arise by reason of the termination of the contracts.
However, in the case of Iannello v Sharpe [2007] NSWCA 61, the fact that a second instalment was payable on the completion date did not overcome the fact that, in the Court’s view, the amount of the second instalment was such that it could not be seen as either a deposit or a pre-estimate of damages and was thus characterised as a penalty. The court also held that a requirement to pay it on the completion date meant that it would by then serve no purpose as an earnest of performance and would be a penalty.
This was also the Court’s conclusion in the case of Boyarsky v Taylor, so despite the reasoning in the Cloud Top case, it is doubtful that a clause saying an instalment is due “on the completion date” will assist a seller when the amount in question has lost its character as a deposit and become penal in nature.
The cases of Rana v Dalla Costa and Sydney Developments Pty Ltd v Perry Properties Pty Ltd are authority for the proposition that a deposit instalment payable on a date falling before the contract completion date can be recovered as long as the total amount is no more than 10% of the price.
Although requiring payment of one or more instalments on property purchases before the completion date will increase the likelihood of recovery, the reality is that most buyers rely on a bank to provide the payment and the banks won’t provide it until settlement takes place.
A genuine pre-estimate of damages?
A clause that states a payment of an agreed amount is a genuine estimate, in advance of a breach, of the damages the seller would suffer if the buyer failed to complete the property purchase will only succeed to the extent that the amount really is a genuine pre-estimate of damages (rather than just being called that in the contract). A court will not uphold it and enforce payment if the amount is not in proportion to the actual loss the seller would be likely to suffer as a result of the breach. It is not sufficient for the parties to call it a genuine pre-estimate if there was in fact no such estimate engaged in.
It would be unusual for a contract for sale of land to call a split deposit instalment a genuine pre-estimate of damages based on a contemporaneous attempt to estimate the loss or damages the seller would suffer if the sale was not completed. It will be difficult for a seller to uphold such a claim in the absence of any contemporaneous evidence of any such calculation exercise having been undertaken.
If the property is eventually re-sold without any reduction in the price in comparison to what the defaulting buyer had agreed to pay, it will be very difficult for a buyer to argue that an amount that is 5% of the agreed price is anything other than extravagant, unconscionable and out of all proportion with the greatest loss that could conceivably be proven from the breach and thus a penalty. Indeed, that was what the Court concluded in Blanco v Wan.
Lessons to be learned for sellers?
What these cases tell us is that if you are a property seller and you want to have a contract that contemplates the buyer paying a split deposit by instalments on property purchases, the unpaid balance of a 10% deposit will not be recoverable unless it is a true earnest and guarantee of performance rather than a penalty payment for the buyer’s breach that is not a genuine pre-estimate of damages.
Is there any way to draft a clause in a contract for sale that would enable a seller to recover the unpaid balance of a split deposit if the buyer defaults and does not complete the property purchase?
Unless a split deposit instalment is part of a 10% total deposit and is expressed to be payable before the contract completion date, the cases strongly indicate that it will be held to be a penalty and will not be recoverable.
Although 10% of the price is the standard contract deposit amount, in places where the property market is running hot and prices are high, there is a strong case for arguing that the deposit amount should be set at 5% of the price rather than expressing it as payable in instalments.
Otherwise, unless a buyer can pay the second instalment before settlement takes place, there would appear to be little point in providing in the contract that the unpaid balance can be recovered if the contract is terminated by the seller, whether it is characterised as a genuine pre-estimate of damages or otherwise.
The main thing for sellers to ensure when considering the deposit amount should be whether the amount paid “up front” will likely be sufficient to cover any expenses or price reduction upon a re-sale to a different buyer. In a strong seller’s market, the price obtained on a re-sale may be little different from (or may even be higher than) the price agreed by the defaulting buyer.
Craddock Murray Neumann Lawyers has extensive experience in drafting and advising on contracts and acting on sales and purchases of all kinds of properties. Our team of expert property lawyers are ready to assist you with all your property needs, and can be contacted on 1300 123 529 or via email.
