Australia: When is a provision allowing a seller to keep a deposit a penalty?
HG Property Litigation Alert: 15 July 2015

Recently we published an article discussing a case where the seller of a property was entitled to keep a $139,000 deposit when the contract of sale failed to settle (see " What happens to a deposit if the buyer is declared bankrupt before settlement?"). As that case and many others of its kind suggest, a contract of sale must be carefully drafted to ensure that you (whether as seller or buyer) are in a favourable position with respect to the deposit if the contract fails to settle.

This is particularly important when the contract provides for the deposit to be paid in instalments. In some cases where a deposit is paid in instalments, a Court could find that the later payments may need to be refunded to the buyer should the contract be terminated.

In the following Alert, Special Counsel Anthony Pitt and Solicitor Borcsa Vass explain a recent decision which provides some guidance on what is to happen with a deposit payable in instalments when the contract is terminated.

Rana v Dalla Costa [2014] NSWSC 1113

In Rana v Dalla Costa, the Court considered whether the requirement to pay the second half of the deposit constituted a penalty in circumstances where the contract was terminated.

Ms Dalla Costa (Seller) entered into a contract (Contract) with Mr Rana and Mr Bousaleh (Buyer) for the sale of a property located at Hamilton (Property). The sale price for the Property was $1,250,000; and the deposit was $50,000.00, which was payable by $25,000.00 on exchange, and the remaining $25,000.00 payable 70 days later.

A brief timeline of what occurred is as follows:

The Seller claimed damages in the Local Court of New South Wales for:

• the unpaid portion of the deposit ($25,000.00);
• the legal costs associated with the terminated Contract;
• the loss of $20,000.00 incurred by the resale; and
• rent received by the Buyer in breach of the Contract.

The Magistrate in the Local Court gave judgment for the Seller comprising:

• the unpaid portion of the deposit ($25,000.00);
• costs of $5,963.71; and
• damages for subletting totalling $8,250.00.

The Buyer appealed to the Supreme Court with respect to the amounts awarded relating to the unpaid deposit and damages for reletting. The Buyer contended that the requirement to pay the second half of the deposit was unenforceable as a penalty.

In deciding that the Seller was entitled to the second $25,000.00 payment towards the deposit, the Court relevantly noted the following:

• A deposit is considered an "earnest of the bargain for its performance that is designed to demonstrate the sincerity of the contracting party who is to pay it" (at [58]).
• A key factor in the penalty issue was the date when the second $25,000.00 payment was required to be made. Here, the Contract required one half of the deposit to be paid on signing the Contract and the second half to be paid 70 days later.Settlement was then not due to occur until over four months after the payment of the second half of the deposit.
• The timing of the second payment so far in advance of the settlement date allowed the second instalment to be genuinely characterised as a deposit, as it was an earnest for performance of the Contract. This distinguished the case from earlier decisions, where the second instalment of a so-called deposit was held to be a penalty, because it was payable on the settlement date if the purchaser failed to settle.This made that payment not an earnest for performance but a penalty for failing to settle (at [63]).
• The Court said that if the second payment had been due on the settlement date, the clause entitling the Seller to keep or recover the deposit "would not have saved that second payment from being considered a penalty" (at [64]).

The Supreme Court ultimately dismissed the appeal and affirmed the decision of the Local Court to award the amounts to the Seller.

Key points

• A contract providing for a deposit payable in instalments must be carefully drafted to ensure that your interests are protected as to your entitlement to the deposit.
• A deposit is less likely to be a penalty when the date for payment of the instalments is prior to the settlement date.
• The judgment highlights how difficult it can be to distinguish between a deposit and a penalty, so it is important to ensure that legal advice is obtained prior to entering into a contract of sale.

© HopgoodGanim Lawyers

Award-winning law firm HopgoodGanim offers commercially-focused advice, coupled with reliable and responsive service, to clients throughout Australia and across international borders.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.