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Commercial property transactions: When is a deposit, not a deposit?

Posted on 16th September, 2019

This week’s blog has been written by Associate Solicitor Richard Flounders, who joined Jacksons in August and is based in our Dispute Resolution and Debt Recovery department in our Tees Valley office.

In the purchase of property it is usual for the buyer to pay a deposit to the seller. This payment acts both as security for the seller and as part payment of the overall purchase price and is usually made upon exchange of contracts.

Generally, if the buyer fails to complete the transaction (whether by choice or inability to do so) the seller forfeits the deposit.

A deposit of 10% of the purchase price is standard, but what if a seller, perhaps with willing buyers queuing up, or nervous that market conditions might imminently change demands a higher deposit?

As Brexit edges closer in an as yet, unclear form the future can be at best described as uncertain. Whilst we are all hoping for the best but no doubt preparing for the worst, those in the property sector could be hard hit in the event of the latter.

With that in mind, requesting a substantial deposit from a buyer in the current landscape may seem prudent. It should ensure that only serious (and hopefully well prepared) buyers proceed.

It also offers substantial compensation to the seller should the worst happen and the sale fall through after exchange of contracts. In the face of unforeseen developments, a retained deposit may well offset a reduction in value of the property asset.

On a practical level, where commerciality allows, a seller seeking a deposit over and above the ordinary 10% seems to be sensible in doing so. The question is whether such a term would be deemed a contractual penalty and therefore void, if challenged by the buyer.

The position under Dojap and Penalty Clauses

In Workers Trust and Merchant Bank -v- Dojap Investments [1993] the buyer of property at an auction had been obliged under the terms of the auction contract to pay a deposit of 25%, well above the “long established and customary” deposit of 10%. When the buyer failed to complete the transaction, the seller forfeited the deposit.
The buyer issued court proceedings seeking recovery of its deposit. This Court of Appeal in Jamaica ordered the 15% excess to be returned to the buyer.

On further Appeal the case was heard by the Privy Council (the final Court of Appeal for British Overseas Territories and Crown Dependencies) before the UK’s most senior Judges.

They held that a penalty clause in a contract was such a provision which requires payment by the party in breach and that such a term is generally unlawful unless that sum can be justified in reference to actual loss incurred by the other party.

However, they further stated that one exception to that general rule is the provision for the payment of a deposit (customarily 10% of the contract price) on the sale of land.

The Judges concluded that 25% was therefore, a penalty and ordered the return of the whole 25% to the buyer (and not just the 15% excess), leaving the seller with nothing (and no doubt a substantial bill for solicitor’s costs).

The current position

Since Dojap is a Privy Council case, whilst not being binding in the UK, it carries significant weight and has long been considered the guiding case on deposits.

In Amble Assets LLP (in Administration) -v- Longbenton Foods Ltd (in Administration) [2012], the High Court cast doubt on Dojap, holding that:

  • There was no binding UK authority on the question of whether deposits of 60% were unreasonable; and
    Even where a deposit is deemed “unreasonable”, it does not follow that the whole sum is recoverable by the buyer.
  • This was an interim decision and not made after a Trial and as such, whether this is the position in UK law remains unclear but did suggest that the courts may well be willing to find exceptions to the rule in Dojap and perhaps recognise that commercial parties, voluntarily contracting with one another are free to agree whatever terms they please.
  • The most recent relevant authority is the case of Parking Eye -v- Beavis [2015], a case on penalty clauses in the context of parking enforcement heard by the Supreme Court which stated that:
    An unreasonable deposit may be challenged as a deposit; and
  • Where the stipulated deposit exceeds the percentage set by long established custom, the seller must show special circumstances to justify it and to avoid that deposit being treated as an unenforceable penalty.

What amounts to “special circumstances” sufficient to justify a deposit over and above 10% is as yet untested. Investment in preparatory works on the land as a pre-cursor to the sale, or expenditure satisfying a condition in the contract (i.e. development or clean up of the land before completion) could well prove to be valid reasons.

The Practical Position

A seller taking the usual 10% deposit appears to be on steady ground in forfeiting the deposit if the buyer fails to complete.

A seller demanding (and subsequently forfeiting) a deposit over 10% is subject to challenge and potentially liable to return the whole deposit, not just that over and above the usual 10%.

Practically, a seller may take the view that the leverage of holding a higher deposit outweighs the risk of being sued should they forfeit it upon non-completion. That said, the additional costs of defending court proceedings may well be significant and should be kept in mind.

That notwithstanding, a seller who intends to commit itself under the sale contract to undertake works on the land before completion or incur some other significant cost not otherwise recoverable if the sale doesn’t complete should consider whether a higher deposit is reasonable and justifiable if challenged.

Careful drafting of sale contracts may assist.

Richard Flounders Associate Solicitor, Dispute Resolution and Debt Recovery.

E:  rflounders@jacksons-law.com

T: 01642 356500

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