Short answer, yes, although there is some inconsistency in the cases. It is an area where lawyers must carefully advise their clients and the safest position is:
- not to split or
- if split then don’t make the balance due on default and potentially not on completion.
Split or deferred outstanding deposits likely as ‘penalty’
When a deposit is paid in part at commencement of the contract and the balance is deferred to a later time in the contract, perhaps on or before completion, or on completion, or on default by the purchaser or any combination, then given the consistent decisions of the courts in modern times, Equity may intervene to classify the deferred outstanding balance of the ‘deposit’ as being a penalty and not recoverable as a true deposit.
Is the outstanding deposit effectively a ‘deposit’?
In considering whether a payment obligation is a deposit (regardless of being called a deposit), consider:
- does it represent a genuine pre-estimate of damages (a deposit in a land sale contract of 10% has long been accepted as a genuine pre-estimate of damages) and does the nature of the payment characterize it as a deposit.
That is:
- is it an ‘earnest of performance’, by being
- actually paid at exchange of contracts or committed to be paid as a deposit as an obligation prior to completion and not linked to a default.
It may sound trite, but effectively a deposit is called a deposit because its true nature is to demonstrate, by paying funds as a deposit, an earnest intention to perform the contract.
In the words of Bryson J:
… a deposit … is the deposit because it was deposited.[1]
The issue is, is it truly a deposit if it is not paid, that is, deposited and is merely a deferred obligation.
There can be no doubt that the safest position is for the full deposit to be paid on exchange and not split or deferred.
However, if the deferred payment (being a 2nd deposit payment) is, in terms of timing, due a reasonable/comfortable time prior to completion there has been support for that position to constitute an ‘earnest of performance’ and so a true deposit payment.
Each case must be considered on its facts. For example, an amount in excess of 10% even if paid on contract commencement may require justification and agreement that it represents a genuine pre-estimate of damages and even then there is the problem of condition 9.1 of the 2022 Edition (and in previous editions) of the Law Society of NSW / Real Estate Institute of NSW Contract for the Sale of Land, which contractually limits the amount of deposit recoverable to 10% of the price.
Recent case law
Some very brief examples of cases to guide us.
- In Ashdown (1999),[2] the deposit was split. First instalment payable 180 days from exchange and second instalment 360 days from exchange, in aggregate 10%. The court held both payments as being truly deposits as they were both due before settlement and were payments ‘in earnest of performance’.
- In Luu (2006),[3] the deposit noted on the front page of the contract was a mere 1% but a further payment of 9% was to be paid before settlement under a special clause. The court held that only the 1% was a deposit and recoverable as a deposit on the purchaser’s default.
- In Iannelo (2007),[4] the contract provided for a 50/50 deposit split of 5% on exchange and 5% on default of any essential obligation or otherwise on settlement. The purchaser defaulted and on appeal the seller was entitled only to retain the 5% deposit paid with the outstanding 5% being a penalty and not recoverable.
- In Rana (2014),[5] a deposit split was payable as to 50% on exchange and 50% due 70 days post exchange (5 months before settlement). The second instalment was not paid and the seller terminated. The purchaser argued that the second deposit payment was a penalty. The court considered the timing of the second payment to be crucial, as it retained the characteristic of being ‘an earnest in complying with the contract’ and was held to be a deposit recoverable by the seller. Had the 2nd instalment been due on completion then the court remarked it would have been a penalty.
- In Sydney Developments (2016),[6] a deposit of 10% was paid on exchange with a further 10% payable 122 days post exchange (5 months prior to completion). Failure to pay the second instalment of 10% resulted in forfeiture of the first 10% instalment. The purchaser defaulted on the payment of the second 10% instalment and the vendor terminated the contract. In short, the purchaser claimed that a 20% deposit was a penalty and sought return of the first 10% paid. The court held that the first 10% payment was truly a deposit and that although the second payment of 10% was less clear, it was due 5 months prior to completion and was capable of being characterized as a payment made as an earnest of performance. Darke J. concluded that the special condition was not a penalty clause and did not affect the retention of the 10% by the seller.
- In Cole (2019),[7] the 10% deposit was split as to half payable on exchange and half payable on or prior to completion. Darke J held that the balance deposit lacked the character of a deposit and could not be characterized as an earnest of performance. Had it been necessary to decide, the court indicated it would have been classified as penal in nature as would standard condition 9.1.
- In Blanco (2021),[8] a 4% deposit was payable on exchange and the balance 6% deposit payable on or before settlement or on purchaser default. The purchaser failed to complete and the seller terminated. Darke J held that the seller was entitled to the 4% instalment paid but not the balance 6% instalment.
The simple message from the above cases is that the second payment must have the character of a deposit, it must be ‘an earnest of performance’. If it is payable “on or before settlement” it may lose its character as a deposit.
- That said, in Jin Yi[9] although the split deposit issue did not need to be determined, the court indicated that had it been required to determine the issue, the second instalment payable on the date for settlement (as opposed to ‘on settlement’) would not have been considered a penalty because on the proper construction of the contract, it was payable on a pre-determined date rather than upon a failure of the purchaser to complete the contract – or it would seem merely ‘on settlement’ which seems to represent a fine line of differentiation with earlier cases.
Key Takeaway
The safest position is to not split the deposit to ensure that the deposit paid on the date of contract is sufficient (when possible) to cover potential market losses on a default by the purchaser and potential liabilities of and claims to be made against purchasers.
Of course, legal risks must be weighed against the commercial risks of each transaction and vendors must decide whether to accept split or deferred deposit arrangements based on market demand.
If the deposit must be split for whatever reason, then the deferred instalments of deposits should be paid on a date that is closer to the date of contract or at the least on a specified date, instead of on default or on completion of the contract.
If you would like to discuss this article with us, please contact Mike Ellis, partner on (02) 9261 5900.
[1] Luong Dinh Luu v Sovereign Developments Pty Ltd & 2 ors [2006] NSWCA 40 Bryson J
[2] Ashdown v Kirk [1999] 2 Qd R 1
[3] Luong Dinh Luu v Sovereign Developments Pty Ltd & 2 ors [2006] NSWCA 40
[4] Iannello & Anor v Sharpe [2007] NSWCA 61
[5] Rana v Dalla Costa [2014] NSWSC 1113
[6] Sydney Developments Pty Limited v Perry Properties Pty Limited [2016] NSWSC 515
[7] Cole v Raykir Holdings Pty Ltd [2019] NSWSC 1017
[8] Blanco v Wan [2021] NSWSC 273
[9] Jin Yi Construction Pty Ltd v Romeciti Eastwood Pty Ltd [2022] NSWSC 56