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We use the expression deposit in a number of different ways. You can put down a damage deposit when renting a car or accommodation or you might pay a deposit when buying a car, a house or paying for a holiday. If you are paying a damage deposit, then the deposit is normally refundable if you return the property without causing any damage. It would also be returnable if you never took up the rental of the property. But, if you have paid an advanced payment for the purchase of a car, holiday or house, then can you ask for your money back if you change your mind and cancel the contract?
Under a contract, a buyer may agree to make an advance payment to the seller. If the buyer defaults or the contract is cancelled after making the advance payment, the buyer’s ability to recover that money depends on whether the payment constitutes a deposit, or merely a part-payment.
What is a deposit and how does it differ from mere part-payment?
The Sale of Goods Act 1979 is silent on the treatment of deposits, and save for the parties agreeing a certain provision, the seller’s rights over the advance payment is one of common law.
Howe v Smith (1884) 27 Ch D 89 defines a deposit in law as: a payment made to secure or guarantee a seller’s performance of the contract. It is considered “security for completion of the purchase”, and unconditional on the actual performance of the contract. Although the second key characteristic of a deposit is similar to that of a mere part-payment – that it forms part of the whole purchase price - a mere part-payment is not a guarantee of the seller’s performance and is therefore treated differently from a deposit.
If a payment constitutes a deposit, then the buyer will not normally be able to recover the deposit. If the payment constitutes a part-payment, then the seller would only be able to keep such amount as is equal to its loss from the buyer’s cancellation.
How do you determine whether the advance payment is a deposit?
Whether an advance payment is a deposit or a mere part-payment depends on what the parties intended when entering into the contact. Howe v Smith specified that if a contract expressly describes the advance payment as a ‘deposit’, but says nothing about whether it is refundable or not, then it will be classed as a deposit in law. From this stems the rule that deposits in law are not refundable if the buyer cancels the contract before completion.
If the contract does not describe the advance payment as a deposit and there are no grounds to believe that the payment is unconditional on the buyer’s performance, it will be classed as a part-payment. This means that it is refundable should the contract be cancelled, subject to any losses the seller may be able to claim if the buyer has cancelled in breach of the contract.
The rule against penalties
The general rule against penalties is that if a clause is a penalty, it will not be enforced beyond the actual loss of the innocent party. This is in contradiction to the rule on deposits, as the deposit may be a much larger sum than the actual loss of the seller, as demonstrated by Griffon Shipping LLC v Firodi Shipping Ltd (2013) EWHC 593, where the deposit was over £2 million and the actual loss was only £275,000.
Historically, deposits have always been treated as the exception to the rule against penalties, with the courts stating in Amble Assets LLP and another v Longbenton Foods Ltd (2011) EWHC 1943 that the specific contractual terms providing for the payment of a deposit could not be challenged as an unlawful penalty. It was rather a means by which a buyer could demonstrate to a seller that it has a genuine commitment to complete a transaction. It further stated that when analysing a situation where the seller has defaulted (and a deposit has been paid), the rules on relief of forfeiture should be followed, rather than the rule against penalties.
Griffon Shipping followed this, and ruled that the seller was entitled to the full amount of the deposit, rather than just its actual loss.
This does not necessarily mean that a seller can ask for a disproportionate or unreasonable deposit and so profit from any cancellations. A buyer may still be able to seek relief of forfeiture in these circumstances, although the law in this area is not well developed.
Whether you are a buyer or a seller, it is important to expressly discuss the advance payment, and agree whether or not it is intended to be a deposit. From a seller’s point of view, it is important to describe part-payments as deposits if it is the intention that the amounts will not be refundable in circumstances where the buyer cancels as this would avoid the need to demonstrate loss suffered by the seller.