The deposit is an “ancient” concept of common law. It forms a crucial component of agreements between two parties exchanging money for goods or services – most commonly when the life of the contract spans multiple days or weeks.
At its core, a deposit is a payment which serves as a form of security towards performance under a contract. The payment typically also serves as a partial payment towards the contract or purchase price upon the completion of the contract, as is the case in hospitality, event planning, trades and construction, and the purchase of land or other forms of real property. While parties are theoretically free to negotiate the circumstances in which a deposit is refundable, the “payor” of a deposit rarely has the opportunity. Thus, the payor will reluctantly (or unknowingly) agree to pay a deposit which is subject to the terms of the recipient’s standard contract or, absent a formal agreement, the common law.
Even when deposits are forfeitable or in circumstances where a deposit payor defaults, commercial vendors dealing with the public will sometimes return deposits in an attempt to avoid potential reputational damage from disgruntled customers. This could lead one to a skewed understanding of the law of deposits, or a false presumption that similar leniency will be afforded in the real estate world.
Deposits – the basic regime.
Stated simply, the common law of deposits is as follows:[1]
- A deposit is paid by one party (e.g. the buyer) to a second party (e.g. the seller) as a “guarantee” for the performance of the first party under a contract.
- If the first party refuses or fails to perform in accordance with the contract, the deposit is forfeited to the second party, regardless of the losses actually suffered by the second party.
Subject to the express terms of a contract, a deposit is generally only returnable where the receiving party repudiates the contract, or the contract is terminated or frustrated through no fault of either of the parties. As such, the fear of forfeiture is a powerful motivator for the payor to complete their obligations under a contract.
In rare circumstances, the payor of a deposit may seek equitable relief from forfeiture where the forfeiture would be considered “unconscionable”. A finding of unconscionability requires the party seeking relief to establish that (i) the forfeited amount is disproportionate to the loss suffered by the receiving party, and (ii) the forfeiture would be “unconscionable”.[2] Determination of whether something is unconscionable is a topic deserving of its own discussion, and involves consideration of several factors such as the level of sophistication of the parties, whether the deal struck was patently unfair, and the presence of good faith negotiations.[3]
It is worth noting that the question of whether a forfeiture is unconscionable is separate from the question as to whether the amount of the deposit was proportionate to the loss. For sake of argument, consider an agreement to purchase a property for a price of $100,000 where a $10,000 deposit is paid by the buyer, and the market is rising. Further suppose the buyer is unable to close and defaults on closing, at which time the fair market value of the property has risen to $200,000. Is it fair that the seller should be entitled to retain the $10,000 deposit, notwithstanding they can find another buyer who is willing to pay $100,000 more than the original price? In cases such as this, it may not seem intuitive (or fair) but the seller would likely be entitled to retain the deposit – a seller receiving a windfall from a forfeiture is not, on its own, grounds to obtain relief from forfeiture.[4]
Relation to Liquidated Damages? Only in appearance, not in effect.
Seemingly in parallel to the law of deposit, another concept evolved in common law: the general rule against contractual penalties. While frequently the subject of judiciary debate,[5] the rule against penalties is the proposition that – notwithstanding parties are free to negotiate contractual terms as they see fit – monetary payments or forfeitures arising directly from a party’s failure to perform are unenforceable unless such amount represents a “genuine pre-estimate of damages” determined at the time of contract. Pre-estimated damages are typically called “liquidated damages”, and such clauses have long been the subject of litigation where parties dispute whether the amount exceeds what could reasonably be considered a “genuine pre-estimate” of damages, thereby rendering the clause unenforceable as a penalty.
Importantly, “deposits” are a carve-out from the usual rule against penalties and should not be conflated with the concept of liquidated damages. While neither the forfeiture of deposit nor a demand for liquidated damages requires the innocent party to prove their losses, the amount of a deposit does not need to be proportionate to the losses suffered by the innocent party upon breach by the payor of the deposit (subject to equitable limitations, noted above), nor does the forfeiture of a deposit serve as an exhaustive remedy for the innocent party.
Sample Deposit Clauses
When dealing in real estate, most parties will encounter the OREA form of commercial purchase agreement frequently used by real estate agents. Its deposit clause reads as follows:
DEPOSIT: Buyer submits upon acceptance ____ Dollars by negotiable cheque payable to ____ “Deposit Holder” to be held in trust pending completion or other termination of this Agreement and to be credited toward the Purchase Price on completion. … The parties to this Agreement hereby acknowledge that, unless otherwise provided for in this Agreement, the Deposit Holder shall place the deposit in trust in the Deposit Holder’s non-interest bearing Real Estate Trust Account and no interest shall be earned, received or paid on the deposit.
While the clause clearly describes the payment as a “deposit”, it does not describe the circumstances in which it will be returned or forfeited. What if the non-completion of the transaction is caused by a condition in favour of the buyer? Does non-satisfaction of the condition result in a return of the deposit? What if the buyer had full responsibility and control over doing the work necessary to satisfy the conditions? If a party defaults, is return or forfeiture of the deposit the only recourse available to the innocent party? These questions cannot be answered by the sample clause above and can only be answered through inferences as to what the parties intended when they signed the agreement.
A more comprehensive deposit clause could read as follows:
Upon acceptance of this Agreement, the Buyer shall pay ____ Dollars (the “Deposit”) by cheque payable to ____ (the “Deposit Holder”) to be held in trust in an interest bearing bank account as a deposit. If the transaction is not completed for any reason except the default of the Buyer, the Deposit (together with all interest thereon) shall be returned to the Buyer forthwith, in addition to all other remedies available to the Buyer at law or in equity if the transaction is not completed as a result of default by the Seller. If the transaction is not completed as a result of default by the Buyer, then the Seller shall be entitled to retain the Deposit and accrued interest in addition to all other rights and remedies of the Seller at law or in equity. If the transaction is completed, then forthwith after closing the Deposit Holder shall release the Deposit to the Seller and the interest earned on the Deposit to the Buyer.
Conclusion
While a buyer may have a legal entitlement to a refund of their deposit, the actual return of the deposit can be significantly hindered by an unwilling or argumentative seller. A seller may point to minor instances of non-performance by the buyer under the contract which the seller thinks (whether justifiably or not) results in forfeiture of the deposit, in which case a buyer may expend more time and resources to appeal to a court to compel return the deposit. Accordingly, real estate buyers should negotiate deposit clauses to clearly identify payments as deposits and to specify – as unambiguously as possible – the circumstances in which a deposit will be refundable or forfeited.
To sum, deposits play a critical role in real property transactions to demonstrate the good intentions of buyers in entering into an agreement to purchase. Parties must be vigilant when negotiating deposit clauses and should seek counsel to understand their contractual and equitable rights when navigating these clauses, particularly when facing a potential default under a contract.
The Real Estate Group at Soloway Wright LLP has extensive experience negotiating and drafting purchase agreements for land transactions in development, commercial and residential contexts and can assist you navigate the complexities of deposits and other contract issues.
[1] March Brothers & Wells v Banton (1911), 45 SCR 338 at p 340, which cites the English decision of Howe v Smith (1884) 27 Ch D 89 (UK).
[2] See Redstone Enterprises Ltd. v Simple Technology Inc., 2017 ONCA 282 at para 15 [Redstone], citing established case law.
[4] Of which the buyer plaintiff was made painfully aware in the case of Tang v Zhang 2013 BCCA 52 (treated favourably in Redstone, above), where the court held that the deposit was forfeited to the sellers, notwithstanding the sellers subsequently sold their property at a higher price to a different purchaser.
[5] See the reasoning of Justice Sharpe in Peachtree II Associates – Dallas L.P. v 857485 Ontario Limited et al. (2005), 76 OR (3d) 362 (CA).
