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Reduced Deposits: what is the law in NSW?

Reduced Deposits- what is the law in NSW
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Perhaps due to the high prices of residential property in NSW, particularly Sydney, it has become increasingly common for purchasers to request, and vendors to agree to, a 5% deposit on exchange.

Despite popular misconception, vendors need to be aware that if they accept a 5% deposit on exchange, they may not be able to successfully sue for 10% if the purchaser defaults.

When accepting a 5% deposit, it has often been the practice of vendors’ solicitors to include a special condition in the contract stating that, if the purchaser defaults, the vendor is entitled to make a demand for the balance of the deposit, to make it up to 10% and forfeit the full 10% deposit. To support that notion, it is sometime the practice of vendors’ agents to insert a 10% deposit on the front page of the contract even when only 5% deposit is paid. However, the case law in New South Wales suggests that such practices will not be effective in recovering the additional 5%.

In the NSW Court of Appeal decision of Iannello & Anor v. Sharpe [2007] NSWCA 61, it was held that despite the existence of ‘deposit by instalments’ clause, the vendor was not entitled to receive the full 10% deposit when the purchaser defaulted on settlement. Instead, the vendor was only entitled to forfeit the 5% deposit paid on exchange. This was notwithstanding that a 10% deposit was written onto the front page of the contract.

The Court held that the obligation to make the ‘second 5% payment’ was not an obligation to pay a deposit or part of a deposit, as this concept is inconsistent with the characteristics of a deposit. It was said that a deposit is security for performance in completing a contract, which a vendor is entitled to forfeit if the purchaser defaults. There would never be a time when the purchaser would be paying the second 5% as security for performance. Rather, the only time the reduced deposit clause obliges the purchaser to pay this sum is when the purchaser has demonstrated that he cannot complete the contract.

The Court instead considered that the promise to pay an additional 5% upon default actually constituted a penalty. Under general contract law, penalties are not enforceable.

In light of the Iannello case, some ‘deposit by instalment’ clauses now avoid making explicit that the further 5% payment is payable upon default/settlement, and instead state that the further sum is generally payable on demand by the vendor. It is doubtful whether this language will make any difference. Any vendor contemplating litigating the validity of such a rephrased clause would have to also be comfortable that the purchaser, having already defaulted, is actually capable of paying a further 5% in any case.

In summary, vendors should be aware that if they accept a 5% deposit on exchange, they may not be able to successfully sue for the remainder if the purchaser defaults.

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