Some contracts for the sale of land require payment of an additional ‘deposit’ amount, if the contract is terminated.
The Victorian Supreme Court recently addressed this question: in what circumstances might an additional ‘deposit’ payment be unenforceable as a penalty?
Land in Seddon, Victoria was sold for $3.5 million, and a deposit of $175,000 (5% of the purchase price) was paid within 14 days of signing.
The vendor validly terminated the contract, as the purchaser failed to settle.
The vendor relied on clause 28.4(a) of the contract to claim a further 5% of the purchase price ($175,000):
“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 …”
The first 4 words of clause 28.4(a) were deleted by hand.
The vendor claimed that only 5% of the 10% ‘deposit’ had been paid by the purchaser.
However the particulars of sale recorded that the deposit was agreed to be $175,000, and this was paid. The vendor contended that the further ‘deposit’ was not a penalty because it was reasonable and not out of all proportion to its legitimate interests.
The purchaser claimed that the obligation to pay a further $175,000 was a penalty and therefore unenforceable.
The Court considered recent High Court authorities on the law of penalties, and a series of NSW Supreme Court (including 2 Court of Appeal) decisions (*) on the interaction between the law of penalties and the payment of ‘further’ deposits.
The following legal principles have been extracted from the judgment:
- The essential character of a deposit is that it is a payment in earnest for the performance of the contract.
- The position of a deposit in the law of penalties is anomalous:
“One exception to [the] general rule [against penalties] is the provision for the payment of the deposit by the purchaser on a contract for the sale of land. Ancient law has established that the forfeiture of such a deposit (customarily 10 per cent. of the contract price) does not fall within the general rule and can be validly forfeited even though the amount of the deposit bears no reference to the anticipated loss to the vendor flowing from the breach of contract.
This exception is anomalous … 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. … in the event of completion of the contract the deposit is applicable towards payment of the purchase price; in the event of the purchaser’s failure to complete in accordance with the terms of the contract, the deposit is forfeit, equity having no power to relieve against such forfeiture.”
- The anomalous position of deposits in the law of penalties protects them, in most circumstances, from invalidity despite the fact that usually a deposit is not a liquidated damages clause (this being the ‘contrasting concept’ to a penalty, in that a liquidated damages clause sets out a sum fixed by the parties to a contract as a genuine pre-estimate of damage in the event of breach.)
- However, a party cannot avoid the law of penalties simply by describing a payment as a deposit, if it does not have the character of money to be paid as a deposit.
- A further ‘deposit’ payable only on termination of a contract is not in the nature of a deposit.
- An unconditional promise to pay an amount on default cannot be a deposit: such a promise will normally amount to a promise to pay a penalty, unless the amount in question is a genuine pre-estimate of damages.
The Court held that the obligation in clause 28.4(a) to pay a further 5% of the purchase price was void as a penalty, and gave judgment for the purchaser.
The Court observed that:
- the obligation to pay a further 5% of the purchase price did not even purport to be by way of a deposit, because the first words in clause 28.4(a), namely “the deposit up to” had been deleted;
- an additional 5% of the purchase price was only payable if the contract ended by a default notice being given by the vendor;
- clause 28.4(a) was not a liquidated damages clause as it imposed an obligation to pay, but did not limit the vendor’s right to claim damages to the extent that they exceeded that payment.
Accordingly the Court held that:
- in these circumstances, in view of the legal principles set out above, the obligation to pay the further sum was void as a penalty;
- the High Court’s decision in Paciocco v Australian & New Zealand Banking Group Ltd (2016) 258 CLR 525 did not affect this conclusion, because the payment was to be made in order to punish the purchaser for inconvenience caused to the vendor, rather than to protect any legitimate commercial interest of the vendor arising from the breach.
In light of this decision (and the other decisions referred to below), contracts for the sale of land should avoid ‘splitting’ a deposit between an initial deposit payment, and a ‘deposit’ payment only to be made upon termination, as the latter is likely to be void and unenforceable as a penalty.
Case citations and notes
The case is Simcevski v Dixon [No 2]  VSC 531 (8 September 2017) per Justice Riordan (Victorian Supreme Court).
* The series of NSW Supreme Court decisions considered by the Court were:
- Luu v Sovereign Developments Pty Ltd (2006) 12 BPR 23,629. The Court of Appeal (Handley, McColl and Bryson JJA) held that a special condition of a contract for the sale of land which provided for the payment of a 10% deposit upon the purchaser’s default was void as a penalty, in circumstances where the contract only provided for the payment of a 1% deposit.
- Iannello v Sharpe (2007) 69 NSWLR 452. The Court of Appeal (Hodgson JA, Santow and Basten JJA agreeing) applied the decision in Luu, and held that a special condition of a contract for the sale of land which provided for the payment of a 10% deposit upon the purchaser’s default was void as a penalty, in circumstances where the contract only provided for the payment of a 5% deposit.
- Kazacos v Shuangling International Developments Pty Ltd (2016) 18 BPR 36,353. Justice White held that a special condition of a contract for the sale of land which required the payment of (the remaining) half of the deposit if the purchaser failed to complete the contract, was void as a penalty.