Vendors of real estate can agree to accept a reduced deposit - but don't call it that!

As property prices have risen sharply over the past several years, more and more purchasers of real estate who do not have cash or do not want to pay the cost of obtaining a deposit bond request that a reduced amount for the deposit be accepted on exchange of contracts.

The NSW Court of Appeal handed down a judgment on 10 March 2006 which:

• Is a good example of why correctly stating the amount of a deposit is important;
• Provides a reminder that penalties cannot be enforced; and
• Gives a wake up call for clients negotiating commercial property deals and for solicitors preparing contracts for sale to make sure we get it right.

The Case

Luong Dinh Luu -v- Sovereign Developments Pty Ltd & 2 Ors [2006] NSWCA 40 Sovereign Developments entered into a contract to sell land at Port Macquarie to Luutin Pty Ltd. The Purchaser's obligations under the Contract were guaranteed by Luong Dinh Luu.

The cover page of the Contract showed:

Price: SIX MILLION, SIX HUNDRED THOUSAND DOLLARS
Price: $6,600,000.00
Deposit: $330, 000.00 $65,000.00 (10% of the price, unless otherwise stated)
Balance: $6,270,000.00 6,535,000.00

Additional Clause 5 of the Contract for Sale read:

"In the event that the Purchaser pays less than ten percent (10%) of the purchase price as deposit, then if the Purchaser commits a default hereunder, the whole of the 10 percent deposit shall become due and payable notwithstanding that this Contract is not completed. This clause shall not merge on completion and the Vendor shall be entitled to sue for recovery of so much of the 10% deposit that remains outstanding as a debt due by the Purchaser to the Vendor."

We can see that originally it was intended that $330,000.00 which is 5% of the purchase price was to be paid as a deposit. This was altered on the Contract by hand to $65,000.00 which is a little less than 1% of the purchase price. Following deeds of variation and other negotiations, the vendor's solicitors served a Notice of Termination of Contract on 8 April 2004. The issue was - did the Purchaser have to pay the "balance of the deposit" or - did forfeiting the amount of $65,000.00 satisfy its obligations under the Contract in relation to the deposit.

The District Court found that the "balance of the deposit" was payable and that the Additional Clause 5 was not void for uncertainty - the NSW Court of Appeal found otherwise.

Why We Pay A Deposit

In his judgment Justice Bryson endorsed the view set out in Ashtown -v- Kirk [1999] 2 Qd R 1:

"A deposit is considered an "earnest" of the bargain or its performance ... that is designed to demonstrate the sincerity of the contracting party who is to pay it. For that reason, it is ordinarily beyond the reach of equitable relief against penalties or forfeiture, at least if it is not excessive or unconscionable in amount, of which in Queensland the equivalent of 10 percent of the purchase moneys is ordinarily considered the upper limit ....."

What If the Deposit is Really a Penalty

Justice Bryson also referred to Ringrow Pty Ltd -v- BP Australia Pty Limited [2005] HCA 71,80 ALJR219 where the High Court stated "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".

What Justice Bryson said of Additional Clause 5

The main observations made were:

• The clause does not expressly provide to the effect that the deposit shall be 10% of the purchase price, but in two places uses language which assumes that the deposit is 10% of the purchase price.
• The assumptions that 10% of the purchase price was payable were inconsistent with the clear provision shown on the cover page of the Contract.
• His Honour said that "no doubt the words used by the parties mean that the deposit was $65,000.00; this is stated in plain language and it cannot be overcome by implications drawn from the language in Special Condition 5 which appears to assume that in some way the deposit is 10% of the purchase price". He also pointed out that if there is any ambiguity, the meaning conveyed by the hand written alteration would be given primacy.

Justice Bryson held the purchaser should forfeit the deposit of $65,000 only.

What This Case Reminds Us to Do

1. Unless agreed to secure the Purchaser's obligations under the contract by payment of a deposit of less than 10%, do not show a figure of less than 10% on the cover page of the contract for sale.

2. Ensure an appropriately worded clause is included in the contract to overcome the argument that the payment of the "balance of the deposit" is actually the deposit and is not in the way of a penalty.

3. Make a commercial decision whether part payment of a deposit will be acceptable or should the Vendor insist on the Purchaser (if they don't have the cash) securing their obligations by way of deposit bond or by some other means.

4. Don't call it a reduced deposit unless that is what you mean.