When there is an ancient custom about “physical tokens of earnest.” In other words, it’s time to talk about deposits.
Lawyers spent many years arguing over the clause in the standard contract produced by the Real Estate Institute of Victoria (REIV) which stated that if the purchaser defaulted, the deposit could be forfeited to the vendor.
Forfeiture of the deposit was simple enough if the vendor was holding it. They would just keep it. However, there were many cases where the contract ended before the full deposit was paid. This led to many arguments over whether the deposit could be forfeited when it had never been paid in the first place. In other words, could the vendor keep something that the vendor did not have?
The REIV tried to address this by changing the standard form contract. Clause 28.4(a) of the standard contract now says that if the contract ends by a default notice given by the vendor “the deposit up to 10% of the price is forfeited to the vendor as the vendor’s absolute property, whether the deposit has been paid or not”.
I have never been convinced that this fixed anything. If you cannot forfeit a deposit that was never paid, then a contract stating that the unpaid deposit is forfeited doesn’t really change that fundamental problem. Still, at least the change made it clear that everyone involved intended the section to apply to deposits that had not yet been paid.
The alternative would have been to get rid of the concept of forfeiture of unpaid deposits altogether. It would be so much simpler just to say that on default:
- If the deposit had been paid it was forfeited
- If the deposit had not been paid, the purchaser would have to pay the balance of the deposit to the vendor immediately, meaning the balance of the deposit would be a debt due and payable immediately.
I’m not sure why the REIV did not take this approach, but there is at least one good reason, which can be found in the recent decision of the Supreme Court of Victoria in Simcevski v Dixon (No 2)  VSC 531 (8 September 2017).
That case was not precisely about an unpaid deposit. In Simcevski, the vendor and the purchaser seem to have been trying to solve a slightly different problem. What do you do when the purchaser does not want to pay a 10% deposit (or they can’t afford to do this), but the Vendor still wants to be able to retain 10% of the purchase price on default?
The creative solution that they came up with was that they agreed on a 5% deposit, which would be forfeit on default as usual, and also agreed that if there was a default, the purchaser would pay another 5% of the purchase price.
This meant that Clause 28.4(a) of their contract said that if the contract ends by a default notice given by the vendor:
“the deposit up to 10% of the price is forfeited as the vendor’s absolute property, whether the deposit has been paid or not”
The Court found that the vendor was entitled to keep the 5% deposit that had actually been paid. The other 5% that was due to be paid if there was a default was a different matter.
A Court will not enforce a provision of a contract if that provision is a “penalty”. Parties can agree on an amount to be paid if a contract is breached, but the amount is generally required to be related to the amount of the loss that the innocent party can expect to suffer. If the amount payable on breach is out of all proportion to the actual loss, this is a penalty and a Court will not enforce it.
This leads to the obvious question of why a vendor should ever be allowed to keep a 10% deposit if there is a default. There is no clear reason why a vendor would lose 10% of the price of a house in this situation. The vendor will certainly have some extra costs, like advertising and agent’s commissions, but there is no particular reason to believe that those costs will be 10% of the price. It seems unlikely that those costs would be $30,000 on the re-sale of a two bedroom unit in Bayswater but $150,000 on the resale of a 4 bedroom house in Mont Albert. In any case, in the current market the vendor will often sell the property for a higher price than the original purchaser had agreed to pay and the vendor may end up suffering no loss at all.
So, if penalties cannot be enforced, why is it okay for vendors to keep a deposit? In Simcevski, the Court effectively said that this is just the way things are, or, as Lord Browne-Wilkinson said in the case of Workers Trust and Merchant Bank Ltd v Dojap Investments Ltd:
“The special treatment afforded to such a deposit derives from the ancient custom of providing an earnest for the performance of a contract in the form of giving either some physical token of earnest (such as a ring) or earnest money.”
This might be a good time for Parliament take a look at this issue. I’m not sure we should base any current law on ancient customs involving tokens, particularly when this makes life just a little bit harder for first home buyers. However, at least until that happens, then the general rule against penalties does not stop a vendor from keeping a purchaser’s deposit if there is a default.
None of this was any help to the vendor in the Simcevski case. The Court found, effectively, that if the whole 10% had been a deposit, then it would not have been a penalty. However, the word “deposit” in Clause 28.4 had literally been crossed out. So, in that particular contract, it was clear that the extra 5% was not part of the deposit. This meant that it was a penalty and the purchaser did not have to pay it.
The Court also referred to a New South Wales case called Iannello v Sharpe, which suggested that calling the extra 5% a part of the deposit probably would not have helped. If the extra 5% was only payable on default, it was still a penalty no matter what the parties called it.
What we learn from this case is that if you are a vendor and you want to recover to deposit if there is a default, make sure the contract clearly requires payment of the deposit, by a set date, in full.
The other things we can learn from this case (and most of the cases that have ever gone to Court) is that it’s important to get good legal advice before you make any changes to a standard form contract. Crossing out a few words may seem like a good solution, but it can result in lengthy, expensive litigation with unsatisfactory results. In Simcevski, the purchaser wanted their deposit back, the vendor wanted an extra 5% of the price, and neither of them got what they asked for. The judgment does not say who is paying the costs, but it seems likely that both parties will end up with a legal bill.