deposit means a sum–

(a) not exceeding 10% of the purchase price payable under an instalment contract; and

(b) paid or payable in 1 or more amounts; and

(c) liable to be forfeited and retained by the vendor in the event of a breach of contract by the purchaser.

instalment contract means an executory contract for the sale of land in terms of which the purchaser is bound to make a payment or payments (other than a deposit) without becoming entitled to receive a conveyance in exchange for the payment or payments

The early payment to the vendor was less than 10% of the purchase price, but the buyer argued once there was any early release of deposit to the vendor, the deposit was no longer “liable to be forfeited” within the meaning of the definition of deposit, thus converting the contract to an installment contract. However, the Court found the buyer still had a contractual right for return of this money if, say, the vendor breached the contract and therefore was still liable to be forfeited. That the payment would be retained by the vendor in circumstances other than the buyer’s default, for example frustration, does not alter that it was liable to be forfeited on breach of contract by the buyer and thus retained its character as a deposit. At paragraph 27 KEANE JA wrote:

It has long been recognised that the essential characteristic of a deposit in a contract for the sale of land is that it is susceptible to being forfeited by a buyer to a seller upon the buyer’s breach. Its essential character is that of a payment guaranteed to the vendor in the event that the purchaser fails to complete the contract. The possibility that the deposit might be lost to the buyer for other reasons as well is not apt to deny its essential character as a guaranteed payment. The circumstance that the purchaser’s entitlement to recover the payment may be lost by virtue of events other than the breach of contract by the purchaser does not detract from the character of the payment as a guaranteed payment to the vendor. Indeed, the circumstance that a payment made by a buyer may be forfeited to the seller by reason of events additional to the buyer’s breach serves to strengthen the character of the payment by the buyer as a guaranteed payment to the vendor

The decision also comments on the legality of early releases of deposits under section 384 and 385 of the Property Agents & Motor Dealers Act 2000.

384 When payments may be made from trust accounts

(1) An amount paid to a trust account must be kept in the account until it is paid out under this Act.

(2) An amount may be paid from a trust account only in a way permitted under this Act.

385 Permitted drawings from trust accounts

(1) A licensee may draw an amount from the licensee’s trust account to pay the licensee’s transaction fee or transaction expenses in relation to a transaction only if–

(a) the amount is drawn against the transaction fund for the transaction; and

(b) the licensee is authorised to draw the amount under this section.

(2) The licensee is authorised–

(a) to draw an amount from the transaction fund to pay a transaction expense when the expense becomes payable; and

(b) when the transaction is finalised, to draw an amount from the transaction fund that is equal to the difference between–

(i) the balance of the transaction fund; and

(ii) the total of the licensee’s transaction fee and any outstanding transaction expense;

to pay the person entitled to the amount or in accordance with the person’s written direction; and

(c) to draw the licensee’s transaction fee from the transaction fund when the amount, if any, mentioned in paragraph (b) has been paid and when the transaction is finalised.

(3) For subsection (2)(b) or (c), if a dispute about the transaction fund arises, the transaction is not taken to be finalised until the licensee is authorised to pay out the transaction fund under section 388.

(4) The licensee must pay an amount mentioned in subsection (2)(b) to the person entitled to it or in accordance with the person’s written direction–

(a) if the person asks, in writing, for the balance–within 14 days after receiving the request; or

(b) if the person has not asked, in writing, for the balance–within 42 days after the person first had the right to the balance.

(5) In this section–

transaction expenses means the expenses the licensee is authorised to incur in connection with the performance of the licensee’s activities for a transaction.

transaction fee means the fees, charges and commission payable for the performance of the licensee’s activities for a transaction.

transaction fund means the amount held in a licensee’s trust account for the transaction.”

The Court rejected the implication the deposit could only be released on settlement by distinguishing that under section 378(1), money might be received by a licensee, either “for a transaction”, or “with a written direction for its use”. The Court concluded that the prohibition in section 385(2)(b) only relates to money paid to a licensee “for a transaction” and not “with a written direction for their use”. At paragraphs 34 to 36 KEANE JA wrote:

There is no provision in the PAMDA which expressly purports to deny the effect of the written direction for the use of the moneys referred to in s 378(1)(b). Equally, there is no provision in s 384 or s 385 which expressly authorises compliance with such a direction. From these circumstances, I would conclude not that a written direction by all parties entitled to the money is sterilised by implication by the terms of s 384(2) or s 385(2)(b), but that the PAMDA simply assumes that the licensee may comply with such a written direction. That is hardly surprising: the obligation to comply with the directions of the owner or owners of funds arises under the general law of agency outside the PAMDA. The PAMDA does not purport to limit the directions which a principal may lawfully give to an agent with the consent of the other persons with whom the principal is involved in relation to the title to that money. So far as the provisions of s 384(2) of the PAMDA is concerned, while no provision of the Act expressly authorises for the payment by a licensee in accordance with the direction of all those with a claim to the moneys, that does not mean that the Act does not permit such a payment. Section 384(2) must, I think, be understood as recognising that compliance with a written direction as to the use of money expressly referred to in s 378(1)(b) is permitted by the PAMDA. There is nothing in the Act to prohibit compliance with a written direction of the kind contemplated by s 378(1)(b) which, as I have said, takes its legal force from the general law. Compliance by a licensee with a written direction is thus permitted by the Act. Where, as the purchaser argues is the case here, the parties have agreed in writing upon the final and absolute disposition of the moneys which have been paid into the trust account of a licensee, there is no occasion for the trustee to abide the finalisation of the transaction.

The Court thought it would be an odd result if, to achieve early release of deposit, the parties had to nominate a deposit holder who was not a licensee under the PAMDA.

At one end of the scale, the property owner conferring the right might merely be humoring the expectant buyer, intending to meet their obligation by offering it first to them at an unrealistic price and once rejected, selling to another at market price, or even below market to an associate. In that case a disappointed buyer might have some remedy on the basis of misrepresentation or misleading behaviour, but their claim is doubtful if their agreement made it clear and plain that this might happen without any recourse.

On the flipside is an obligation on the owner for any sale to be to the expectant buyer unless someone is willing to pay more. This is colloquially abbreviated by some as a right of first and last refusal. In between these 2 poles are many variations. For example, after the first refusal, the property may be freely sold unless it is on terms materially more favourable than those first offered. Another is that the first offer must be, objectively, at the market price and independent valuers can be enlisted to ensure it. In other words, the legal drafting of these clauses is critical as the right is not a settled legal concept.

Unlike an option, a right of first refusal appears to confined to a personal, contractual interest not capable of amounting to an interest in land which would justify a caveat or a Court order of specific performance. In Octra Nominees Pty Ltd v Chipper [2007] a decision in the Federal Court of Australia, Honourable Justices Tamberlin, Gyles and Gilmour warn against interpreting a right of first refusal as a kind of proprietary interest enforceable against third parties. In that case, a tenant declined to accept an offer to them to purchase the freehold which was then sold to a third party for the same price. The time stipulations in that contract of sale were subsequently varied to the buyer’s benefit. The tenant then ambitiously embarked on proceedings, with some early success, effectively seeking to be substituted as the buyer under the terms of the amended contract. Tamberlin, Gyles and Gilmour held that the tenant only had a “right of first refusal, not of first and last refusal. Thus, in the absence of any suggestion of bad faith, prior arrangement, fraud, mistake or misrepresentation, the contract may be later varied between the grantor and the third party purchaser, and this will not revive the right so that a new offer must be made on the varied terms to the grantee. The right is exhausted when an offer to sell is rejected and the offer or a less advantageous offer is accepted by a third party.”

The judgment talks about the limits of rights of first refusal, in particular that they should be exhausted once a contract of sale has been properly entered into and not enlivened by a subsequent change in that contract. There is an implication in the judgment that a clause that appears to enliven the right upon contract variations would cause too much commercial uncertainty to be enforceable.

” 24 (2) (e) .. work performed by a PAMDA licensee, or by an employee of a PAMDA licensee, if the licensee or employee only fills in details in a preprinted contract or other document as part of performing the work of a PAMDA licensee and does not give advice about the contract or other document or the details that are filled in; ..”

The Queensland Law Society put out a call to all solicitors in its October 17, 2007 e-mail update asking for information  about non-lawyers providing “conveyancing services” in breach of section 24.  It has taken consumer advocate Tim O’Dwyer M.A., LL.B to point out the really significant impact of the section is on the current peculiarly Queensland culture of real estate agent control of contract formation.  The section 24 exemption for filling in details would not seem to extend to the routine drafting of special conditions.  See O’Dwyer’s piece “Catch 24 on Agent’s Contracts”.

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.