When does a deposit become a penalty?

Deposits hold a special place in contracts for the sale of land and do not fall within the general rules about penalties. Where a purchaser defaults the deposit (customarily 10 per cent) can be forfeited even though the amount of the deposit bears no reference to the anticipated loss to the vendor flowing from the breach of contract[1]. The vendor can forfeit the deposit as a minimum sum even if it makes a profit on the resale. On the purchaser’s breach, a vendor is also not limited to recovering the amount of the deposit; but may recover any deficiency on resale (after taking into account the forfeited deposit).

The special treatment afforded to deposits “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…”[2].

Where the principles governing deposits and the law governing penalties interact is where the contract provides, for example, for a deposit of less than 10 per cent to be paid and, in the event of a default, for the whole of the 10 per cent deposit to be paid. In such cases the requirement to pay the additional amount on default has been held to be a penalty[3].

In Simcevski v Dixon (No 2) [2017] VSC 531 Riordan J considered a contract for the sale of land that provided for the payment of a deposit equivalent to 5 per cent of the purchase price. Upon default by the purchaser, the vendor sought payment of a further 5 per cent of the purchase price relying on clause 28.4 of the contract which provided that:

‘If the contract ends by a default notice given by the vendor:

(a) the deposit up to 10% of the price is forfeited as the vendor’s absolute property, whether the deposit has been paid or not; and”

While His Honour accepted that the anomalous position of deposits in the law of penalties protected them in most circumstances, he held that the obligation in cl 28.4 to pay further sum of 5% of the price was void as a penalty because:

• the obligation to pay a further sum of 5% of the purchase price did not purport to be by way of a deposit because the words in cl 28.4, being ‘the deposit up to’, had been deleted; and
• the further sum of 5% was only payable ‘[i]f the contract ends by a default notice given by the vendor’.

His Honour said:

“In my opinion, the circumstances of this case lead to the position, described by the Court of Appeal, in Melbourne Linh Son Buddhist Society Inc v Gippsreal Ltd[4], as:

[t]he irresistible inference that arises from [the] evidence and the inherent circumstances of the … transaction is that the [payment is to be made] in order to punish the [breaching party] for the inconvenience its conduct caused to the [innocent party] … rather than to protect any legitimate commercial interest of the [innocent party] arising from a breach … by the [breaching party].

His Honour also held that cl 28.4 was not a penalty simply because it was not a liquidated damages clause (ie a clause that refers to a sum fixed by the contract as a genuine pre-estimate of damage in the event of breach), but rather because it imposed an obligation to pay without any limit on the vendor’s right to claim damages to the extent that they exceed that payment.

Drafters of contracts must make it clear what is and what is not a deposit and provide for that sum to be paid without any reference to a breach. The case contains an extensive discussion of all the relevant caselaw.

[1] See: Workers Trust and Merchant Bank Ltd v Dojap Investments Ltd [1993] AC 573; Kazacos v Shuangling International Development Pty Ltd (2016) 18 BPR 36,353.

[2] Workers Trust, 578-9.

[3] See, among others: Luu v Sovereign Developments Pty Ltd (2006) 12 BPR 23,629; Iannello v Sharpe (2007) 69 NSWLR 452.

[4] [2017] VSCA 161.

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Vendor not entitled to interest on unpaid contract price where contract terminated

Vendors who terminate contracts for the sale of land on the ground of a default by the purchaser often claim interest on moneys that have not been paid calculated from the date of the breach to the date of termination. Clause 25 of the general conditions of the standard form of contract concerning the sale of land prescribed by the Estate Agents (Contracts) Regulations 2008 (Vic)  provides that:

“A party who breaches this contract must pay to the other party on demand:

…… ; and

(b)       any interest due under this contract as a result of the breach.”

Does clause 25(b) entitle a vendor to interest on the contract price from the date of a breach by a purchaser to the date the vendor terminates the contract?

Two cases in the Supreme Court of Victoria suggest that the answer to this question is “yes”. In Portbury Development Co Pty Ltd v Mackali [2011] VSC 69 the plaintiff sold a property for $1,600,000 with a deposit of $60,000, with the balance of purchase price payable on a nominated date. The defendant failed to complete and the plaintiff terminated the contract. The court accepted that the plaintiff’s termination was valid. The plaintiff’s claim included damages being, among other things, the difference between the contract price and the value of the property at the time of termination and “interest between default and rescission” based on a clause similar to clause 25. The court awarded the amount of interest claimed to the plaintiff, noting that such interest was under the terms of the condition payable on demand and remarking at [27]:

“By the notice of rescission the plaintiff made an appropriate demand for that interest. Accordingly, the plaintiff is entitled to judgment against the defendant for the sum of interest claimed by it.”

In Pettiona v Whitbourne [2013] VSC 205  the facts were similar to those in Portbury. The price of the property was $5,850,000. The purchaser failed to pay the balance of purchase price on the date nominated for settlement. A notice of default was served and the contract was terminated. The plaintiff claimed, amongst other things, interest on the unpaid balance for the period of default. The claim for interest, which was made under the terms of the contract, was not disputed by the defendant.

A recent case in the County Court of Victoria suggests that the answer to the question posed is “no”. In Yvonne Maria Van Der Peet Bill v Allan James Clarke [2015] VCC 1721 Judge Macnamara declined to follow Portbury and Pettiona in deciding that a vendor of land was not entitled to interest from the date of the breach to the date of the termination of the contract. At [77] His Honour analysed the issue as follows:

“To put it in a nutshell, how can interest be awarded upon an alleged principal sum that ultimately was never payable?”

In answering that question His Honour said it was necessary to go to “some fundamental principles of the law of vendor and purchaser” and “one of Sir Owen Dixon’s most celebrated judgments” in McDonald v Dennys Lascelles Limited (1933) 48 CLR 457 at 477-479. In McDonald the guarantors of a purchaser’s obligations under a terms contract contended that upon termination by the vendor the contract was cancelled as to the future and, because there would be no transfer of the property, the purchaser’s obligation to pay an outstanding instalment of the purchaser price came to an end. The High Court accepted the guarantors’ contention. Because the guarantors’ obligation was a secondary one their obligation was also terminated.

His Honour also considered the decision of the New South Wales Court of Appeal in Carpenter v McGrath (1996) 40 NSWLR 39 which he said accorded with the general principles that emerged from McDonald. In Carpenter the purchaser failed to complete a contract to buy land and the trial judge awarded damages to the vendor which included a claim for interest from default until termination. On appeal the Court of Appeal disallowed the claim for interest from default until termination. The Court’s reasoning was in effect that once the contract ended the vendor could not have sued for the purchase price and was relegated to a claim for the loss of the bargain. The interest operated to increase the amount payable on completion and because the purchase moneys were not payable interest could not be claimed.

Judge Macnamara said that while Portbury and Pettiona supported the award of interest, general principle flowing from the analysis in McDonald pointed away from an award being made and therefore the claim for interest failed.

A question that is unresolved is whether the position might have been different if the vendor had re-sold the land rather than retaining it because the vendor would, in determining the loss on any resale, arguably have been entitled to treat the purchase price as constituted both by the contract price and the interest payable under the contract.

 

Second Notice to Complete Revives Terminated Agreement – Contract Sale of Land

A vendor who has terminated a contract for the sale of land should be wary of serving a second notice to complete because the second notice revives the agreement that has been terminated.

In Rona v Shimden [2005] NSWSC 818 a vendor under a contract of sale claiming to have terminated the contract, gave notice to complete which was expressed to be without prejudice to its contention that the contract was terminated. White J at [86] analysed the position as follows:

The giving of a notice to complete may give rise to an estoppel which precludes the party giving the notice from asserting that the contract has been terminated. Here, the purchaser did not do anything consequent upon the service of the notice which could create such an estoppel. Estoppel aside, the service of a notice to complete without prejudice to a prior notice of termination takes effect as an offer to revive the agreement, capable of being accepted by performance in accordance with the terms of the notice to complete: Lohar Corporation Pty Ltd v Dibu Pty Ltd (1976) 1 BPR 9177 at 9184, 9187.

In Naval and Military Club v Southraw [2008] VSC 593 Byrne J accepted this analysis. See: also Portbury Development Co Pty Ltd v Ottedin Investments Pty Ltd & Ors [2014] VSC 57.