A deposit is common in commercial transactions across many industries. Interestingly, there is a common misconception that the principles relating to the forfeiture of deposits are different depending on whether the contract relates to the sale of land or not. This article will explore the function of a deposit, and circumstances where a deposit may be forfeited.
Case Law, New and Old
In the case of Howe v. Smith (1884) 27 Ch. D. 89. , the English Court of Appeal held that the two functions of a deposit are to be:
- 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 guarantee of due performance, that is, security of the performance.
Therefore, if the purchaser doesn’t complete the agreement/contract, it would appear that a deposit may be forfeited.
In the case of Commissioner of Taxation v Reliance Carpet Co Pty Ltd (2008) 236 CLR 342, the High Court of Australia stated that:
“In the absence of an express contractual stipulation to the contrary, a vendor terminating a contract for default by the purchaser in completion is entitled to retain the deposit, as an implied term upon which the deposit was provided…”.
This means that a vendor is entitled to retain the deposit if a purchaser defaults on a contract.
Claims for Forfeiture of Deposits
However, it should come as no surprise that it is at the time when a vendor/seller seeks to forfeit a deposit that it is likely to be met with the claim that any such action is unlawful. The most common objection to any such forfeiture is that it would be punitive in nature and is thus not permitted under the common law.
In such a case, the defaulting purchaser would be required to satisfy a court that it is entitled to relief against forfeiture. This would be on the basis that the amount to be forfeited is not a genuine pre-estimate of loss, but is, in fact, not proportionate to the amount of loss that could be suffered by the vendor/seller.
It will not necessarily help the vendor’s situation that the relevant agreement refers to the deposit as a ‘deposit’, ‘a genuine pre-estimate of loss’ or as ‘fair and reasonable’, as this will be regarded as a matter for the court to decide. The court will likely take into account the relative bargaining positions of the litigants (among other things) at the time the parties entered into the contract. It is important to note that relief against forfeiture is a discretionary remedy, and so each case will be determined on its own facts.
How Can I Avoid this problem as a vendor/seller?
The first and primary way to avoid this problem is to ascertain what the likely damages suffered due to a defaulting purchaser (who has paid a deposit) will be and to set the deposit accordingly. Where a purchase price is to be paid over a lengthy period, there may be scope for a higher deposit that is still fair and reasonable.
The second way relates to the manner in which a vendor/seller acts in terminating the relevant agreement. A vendor/seller who stands to benefit (or at least prevent loss) from the forfeiture of a deposit should act prudently to ensure that it will not be regarded by a court as having unfairly sought to bring the contract to an end. By making sure that any termination of the agreement is done fairly, a vendor/seller is more likely to convince a court to exercise its discretion not to grant relief against forfeiture.
For advice on ensuring that your commercial contracts will be enforceable or as to whether a deposit may be forfeited, contact us on 1300 544 755, and speak with one of our commercial lawyers.