Robert J Garvey, Solicitor

The New South Wales Court of Appeal has given a needed to refresher on the nature of a deposit and in doing so confirmed as worthless the typical “reduced deposit” clause.

Iannello & Anor. v. Sharpe [2007] NSWCA 61 involved a contract for the sale of a house for $4.5 million where $224,000.00 was paid as deposit but including a special condition as follows.

“Notwithstanding anything else herein contained, the Vendor shall accept, on exchange of this Agreement, payment of $225,000.00 being part of the deposit. The parties expressly agree that if the Purchaser defaults in the observance or performance of any obligation hereunder which is or has become essential the balance of the deposit, namely $225,000.00, shall become immediately due and payable and the Purchaser shall forfeit the whole of the sum of $450,000.00 pursuant to Clause 9 hereof to the Vendor.”

The Court of Appeal cited Luu v. Sovereign Developments Pty. Limited [2006] NSWCA 40 as a case with similar facts because on the front page of the contract in that case the price was $6.6 million and provided for a deposit of “$65,000.00 [followed by] 10% of the price unless otherwise stated” coupled with a special condition as follows.

“In the event that the Purchaser pays less than ten percent (10%) of the purchase price as deposit then if the Purchaser commits a default hereunder the whole of the 10% deposit shall become due and payable notwithstanding that this Contract is not completed. This clause shall not merge on completion and the Vendor shall be entitled to sue for recovery of so much of the 10% deposit that remains outstanding as a debt due by the Purchaser to the Vendor.”

Of course, in the Luu case, the purchaser defaulted and the vendor claimed the full 10% as damages. While allowed in the first instance, the Court of Appeal overturned that, holding that this “balance of deposit” amount was not part of the deposit but really a penalty. Bryson JA’s leading judgment on the relationship between deposits and penalties was quoted.

“.. Where parties make an agreement for a sale which is to be completed at some time in the future it is unremarkable and only to be expected that the vendor will require the purchaser to pay some part of the purchase money straight away so as to show that the purchaser is in earnest in committing himself to pay the rest, on the understanding that the purchaser will not get his earnest money back if he does not complete the sale. For contracts of sale of land it has long been customary practice and established law that the purchaser pays a deposit on account of the purchase money when the contract of sale in writing is made, and cannot recover that deposit if he later fails to complete the bargain and pay the rest; whether or not the vendor’s losses are actually more or less than the amount of the deposit. Notwithstanding the apparent inconsistency, the invalidity of contractual penalties does not apply to contractual provisions for forfeiture of reasonable deposits in sales of land. … The exception from the law relating to penalties relates and relates only to deposits, that is, to payments which truly have the character of earnest money paid on or in relation to entering into the Contract, and although provisions of contracts almost always establish what the deposit is, it is not open to parties to avoid the operation of penalties law by designating a payment or an obligation as a deposit if it does not otherwise have that character.”

In summary, calling it a deposit did not make it a deposit. An essential characteristic of a deposit is payment in earnest and this element was absent once the purchaser was in default and could not complete the contract.

If not a really a deposit, the question remained whether the so-called balance of deposit was a genuine pre-estimate of damages. In both the Luu case and in Iannello & Anor. v. Sharpe, it was concluded the claimed “balance of deposit” amounts greatly exceeded the vendors’ losses and was a penalty and not enforceable.

While the Court’s analysis on deposits and penalties was welcome, there was no convincing analysis on the interaction of the issue of liquidated damages, only a perfunctory note that a genuine pre-estimate of damages clause would overcome the rule against penalties.

The upshot: Do not rely on the enforceability of a payment described as a deposit payable on default. Payment (and forfeiture) of a good faith deposit due in instalments is fine, but upon a default, unless claiming actual damages, any further amount payable must on proper construction be liquidated damages (i.e. a genuine pre-estimate of damages) in which case proof of actual losses is not required. It is worth mentioning here too that a self-described liquidated damages clause may be found to be, in substance, an unenforceable penalty where it is extravagant and unconscionable compared to the maximum possible loss.

The issue of whether a trustee’s right of indemnity can be excluded by trust instrument was considered by the Honourable Justice Debelle of the South Australian Supreme Court in MOYES & ANOR v J & L DEVELOPMENTS PTY LTD & ANOR (No 2) [2007] SASC 261 in a judgment delivered on 11 July 2007.

The trustee (J&L) had purchased land and then gone on to win an appeal in the Environment Court against a local Council decision declining its request to build a house on the land. The neighbours and the Council appealed further to the Supreme Court and succeeded in reinstating the original Council decision, ordering costs against J&L as trustee.

J&L refused to pay the costs. As trustee, J&L amended the trust deed so that it expressly stated: “the Trustees shall not be indemnified out of the Assets of the Trust Fund”. Soon after J&L resigned as trustee and was replaced as trustee by a new company, Palm Hills Pty Ltd, which became the new registered owner of the land and which promptly sold the land.

The question was whether the order for costs could be enforced against the sale proceeds of the land. Justice Debelle referred to a division of judicial opinion on whether a trustee’s right to indemnity against trust assets can be excluded by trust instrument. The right was either an inseparable incident incapable of being excluded or a matter akin to contract law: if a trustee is willing to disadvantage themselves in that way they should be free to do so.

The answer was found in the Victorian Trustee Act 1958, which provides:

A trustee may reimburse himself, or pay or discharge out of the trust premises, all expenses incurred in or about the execution of his trust or powers.

It was noted the provision was enacted not only in the interests of trustees and beneficiaries but also in the public interest, especially creditors. The trust amendment removing the indemnity was found to be void against public policy and inconsistent with the statute.

There is little doubt the same decision would be reached in Queensland with the corresponding provision being found in section 72 of the Trusts Act 1973

A trustee may reimburse himself or herself for or pay or discharge out of the trust property all expenses reasonably incurred in or about the execution of the trusts or powers.

A Queensland Supreme Court application on whether a family trust controller had successfully replaced himself before his death has been decided in the negative. In Jenkins v Ellett [2007] QSC 154, Douglas J pondered for some 6 months after hearing a typically elliptical clause allowing for changes to a discretionary trust:

“The Trustee may by Deed revoke add to release or vary all or any of the Trusts declared or any Trusts declared by any variation, alteration or addition made from time to time and may by the same or any other Deed declare any new or other trusts or powers concerning the Trust Fund but so that the Trustee shall not have any power to revoke add to or vary any of the Trusts so that the Settlor may acquire a beneficial interest in the Trust Fund or any part of it nor to effect [sic] the beneficial entitlement of any Beneficiary to any amount applied for him prior to the date of revocation or alteration and any other person or persons upon whom any power or powers so conferred on him or them. Upon this exercise of any release and revocation pursuant to this clause the power so released and revoked shall be absolutely and irrevocably determined.”

Mr. Jenkins, the original trust controller, relied on the clause to exercise power as trustee to amend the trust schedule to remove himself and install his only surviving child (Ellett – the respondent) as controller. After Mr. Jenkins died, probate was granted to his granddaughter (Jenkins – the applicant) who assumed control under the trust deed as the executor of the original controller.

Ellett’s counsel relied heavily on the Property Law Act 1974 which provides:

“205 Disclaimer etc. of powers

(1) A person to whom any power, whether or not coupled with an interest, is given, may by deed disclaim, release or contract not to exercise the power, and after such disclaimer release or contract shall not be capable of exercising or joining in the exercise of the power.

(2) On such disclaimer, release, or contract, the power may be exercised by the other person or persons or the survivor or survivors of the other persons to whom the power is given unless the contrary is expressed in the instrument creating the power.”

Jenkin’s counsel argued the power of the controller to remove and appoint trustees was entrenched and that it would be self-defeating to allow a trustee to get around that by amending the deed to remove the controller.

Douglas J saw the issue as a question of construction and context. He quoted Thomas on Powers (1^st ed., 1998) at pp. 585-586, paras 14-31 to 14-32 seemingly as the touchstone.

“In all cases, the scope of the relevant power is determined by the construction of the words in which it is couched, in accordance with the surrounding context and also of such extrinsic evidence (if any) as may be properly admissible. A power of amendment or variation in a trust instrument ought not to be construed in a narrow or unreal way. It will have been created in order to provide flexibility, whether in relation to specific matters or more generally. Such a power ought, therefore, to be construed liberally so as to permit any amendment which is not prohibited by an express direction to the contrary or by some necessary implication, provided always that any such amendment does not derogate from the fundamental purposes for which the power was created. Thus, a power of amendment will undoubtedly be capable of making amendments which are essentially ancillary to, and for the better execution of, such fundamental purposes, e.g. so as to substitute an easier form of communication or service for the one originally stipu­lated, or so as to make other powers exercisable in writing rather than by deed, or, indeed, introduce other amendments which are not simply administrative or managerial in nature. It does not follow, of course, that the power of amendment itself can be amended in this way. Indeed, it is probably the case that there is an implied (albeit rebuttable) presump­tion, in the absence of an express direction to that effect, that a power of amendment (like any other kind of power) cannot be used to extend its own scope or amend its own terms. Moreover, a power of amendment is not likely to be held to extend to varying the trust in a way which would destroy its ‘substratum’. The underlying purpose for the furtherance of which the power was initially created or conferred will obviously be paramount.”

Douglas J went on to notice that “this Trust” was defined in the deed to include the schedule (where the controller is named) but the power to amend clause referred to “the Trusts declared”. The difference between the singular and plural limited the power to amend to the trusts created in the document, not the document itself. Douglas J also affirmed the executor applicant, Jenkin’s argument based on common sense by describing the respondent’s position as “destroying the substratum of the deed”.

Less convincing was Douglas J’s handling of the statutory disclaimer issue. He found that a disclaimer under section 205 of the Property Law Act had not been sufficiently invoked, but even if it had been, because the purported replacement under the deed was not authorised, such a statutory disclaimer was invalid. There was no further analysis and it was unclear if his reasoning was that the deed sufficiently expressed a contrary intention.