How the payment of deposits is structured under certain business and franchise transactions could potentially be affected after a recent judgement in the New South Wales Court of Appeal.
In the recent case of Iannello & Anor v Sharpe, the New South Wales Court of Appeal considered when payments by the purchaser of land will properly be characterised as a 'deposit' as opposed to 'payments', which are a penalty and unenforceable.
In addition to the ramifications for sale of land transactions, the principles in this decision may well apply to business transactions such as sale of business agreements and other similar agreements, which require payment of a deposit on signing.
Iannello’s case concerned a contract for the sale of a $4.5 million property in Hunters Hill, New South Wales.
On the exchange of contracts, the purchaser paid a deposit of $225,000, being 5% of the total purchase price rather than the common requirement for the deposit payable on exchange of 10% of the purchase price.
The contract for sale included a special condition, which stated that if the purchaser was in breach of the contract:
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.
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.
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We discuss whether certain clauses commonly found in ordinary commercial contracts could be considered to be penalties.
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