- The courts have accepted that the principles relating to penalties do not apply to deposits paid on contracts for the sale of land that are true deposits and are for reasonable sums.
- There have been some decisions where ‘split-deposit’ special conditions have fallen outside of that exception and have been characterised as a penalty clause and held to be unenforceable.
- In light of recent cases, solicitors need to carefully consider the drafting of their ‘split-deposit’ special conditions and should advise vendors that they may not be able to recover a second or subsequent instalment of a deposit, which is due on breach of the contract.
Consider the following scenario: a vendor under a contract for sale of land allows the purchaser to pay the usual 10 per cent deposit of the purchase price by instalments, with 5 per cent due on exchange, and the balance on completion or default. The special condition makes clear that the payment in two instalments represents the deposit. The purchaser subsequently defaults in an essential respect. Can the vendor recover the second instalment?
According to clause 9.1 of the standard contract, the answer is yes. The standard contract clearly allows the vendor to keep and recover the 10 per cent deposit where the purchaser does not comply with the contract in an essential respect. However, the issue with special conditions allowing for a ‘split-deposit’ or ‘top-up’ is whether the subsequent instalment of the deposit can be characterised as part of the ‘deposit’.
Several cases over the past decade have held that where the subsequent instalment falls short of its characterisation as a true deposit, then it will be necessary for a court to consider whether the amount is a genuine pre-estimate of damage or a penalty. If it is a genuine pre-estimate of damage, it will be upheld. If not, it will be struck down as a penalty and the vendor will be unable to recover that instalment.