When a 'deposit' payable under a contract may not be a deposit

• the balance of the ’deposit’ (a further 5% of the purchase price) was immediately due and payable to the vendor, and
• the purchaser would forfeit the entire deposit amount, being the 5% paid on exchange as well as the additional 5% which was not paid on exchange.

The purchasers were ultimately unable to secure finance to complete the purchase of the property and after issuing a notice to complete, which was not complied with, the vendors terminated the contract, kept the $225,000 deposit and then commenced proceedings to recover the additional 5% of the ‘deposit‘ from the purchasers.

Decision

The Court of Appeal held that only the initial amount of $225,000 was a ‘true’ deposit. The vendor could not recover the additional 5%. The Court said a payment made on entering into a contract for sale will only have the characteristics of being a ‘deposit’ if it is made to demonstrate that the purchaser is serious about paying the balance of the purchase price. This is because the payment is made on the understanding that the deposit paid will be forfeited if the purchaser does not complete the transaction.

The Court found that the remaining 5% was not a true deposit because under the contract it only became payable when there was a breach of the contract, and therefore it was in fact a penalty which was not enforceable against the defaulting purchaser.

Lessons to be learnt

• If selling land or a business be very careful about agreeing to accept partial deposits or a lesser amount than is stipulated in the contract. Seek legal advice if a purchaser wishes to pay a deposit which is an amount less than what the contract stipulates.
• Before issuing any contract, consider whether you need a 5% or 10% deposit clause. If 5% is sufficient, draft a clause to that effect.
• It is not possible to avoid the law relating to penalties by designating a payment as a “deposit” if it does not otherwise have the characteristics of a deposit.
• Deposits can still be paid by instalments but seek legal advice about how to draft an enforceable clause.

Thomson Playford Cutlers works with franchisors as a strategic partner to improve overall network performance. We manage compliance issues and address the legal considerations that contribute to franchise network efficiency, profitability and expansion.