Deposits and Defaults

The good times for the property market seem to have faded rather quickly, with many suffering the hangover from the party that was the property boom.

Part of the fallout is a sharp rise in the number of purchasers unwilling or unable to complete contracts for the purchase of properties that were entered into just before or at the time of the decline in property prices. Perhaps the most affected has been residential property, with many purchasers entering into contracts to buy new build residential properties when prices were at the highest. After exchange of contracts, there would have then been a period during which the builder was to construct the property and by the time these houses were finished the market had fallen.

Because of the banking crisis this has had a "double whammy" effect. As the house price falls, the amount that the banks will lend also falls because they will only lend a percentage of the present value of the property ("Loan To Value"). In addition, banks are now tightening their belts, and the loan to value has also fallen from 95% and above to much more conservative levels.

For many this simply means that they can not afford to buy a property. However, those who have already entered into contracts to buy will now be facing a breach of contract if they are unable to find the funds to complete. So what happens if a deposit has been paid?

Buying a house from a legal point of view largely involves two stages; exchange of contracts and completion. On exchange of contracts the purchase becomes legally binding and the buyer must complete the purchase of the property on the legal completion date. On exchange of contracts it is usual for a deposit to be paid as an assurance the buyer will proceed.

The majority of contracts provide for a deposit equal to 10% of the purchase price. However, it is worth noting that in a lot of cases buyers would normally pay 5% or less than this. It is tempting for these buyers to believe that they have got away with either paying no deposit or paying a much reduced sum. In the first instance, the terms of the contract should be checked to find out what was actually agreed in relation to the deposit. In this respect it is relatively common to find a clause in the contract that, even if a lesser sum for the deposit is accepted, the full 10% will remain due. This means if the buyer did default the seller would become entitled to ask for the balance of the deposit to be paid immediately as a starting point for any claim.

Buyers in this position may feel that it is unfair that they have entered into a contract in good faith, believing that they would be able to purchase a property with the aid of a mortgage. They may feel that it is not their fault the banks are now not lending them enough money to buy a property. However, between the buyer and the seller the contract clearly provides for the buyer to pay the agreed purchase price on completion. The buyers inability to get funds from the bank will not in itself entitle the buyer to withdraw from the contract.

The question then arises in what circumstances can the buyer get back the deposit? In respect of a contract for the purchase of a house, the contract will usually provide that the seller can forfeit the deposit if the buyer defaults.

Even if the contract states that the seller can forfeit the deposit, Section 49 (2) Law of Property Act 1925 provides that the Court has a discretion as to whether to return the deposit if it thinks fit.

The case of Maktoum [1980] used to be regularly relied on by defaulting buyers. Here the buyer failed to complete the purchase and the seller forfeited the deposit but sold the property for more meaning the seller had actually benefited from the buyers default. The court ordered the return of the deposit to the buyer.

These days the leading case is Omar [2001] in which the Court held that there would have to be special circumstances to justify a deposit being returned. More recently, the High Court and Court of Appeal have affirmed this approach in the case of Midill v Park Lane Estates [2008]. In this case the buyer agreed to purchase a property for £4m with a deposit of £400,000.00 having been paid. The buyer then failed to complete the transaction and the seller forfeited the deposited. The seller then resold the property for £4.3m.

Notwithstanding the fact that the seller had actually profited from the buyers default, the Court still found that the seller was entitled to retain the deposit. It is interesting in this case that the Court noted that there were no "special circumstances" which would justify a departure from the approach in Omar. The mere fact that the property was sold for more to someone else did not make the case special or exceptional. The Court of Appeal also emphasised that the provision for a deposit on a sale of land (as opposed to other contracts) is best regarded as an exception to the general principles governing penalties in contracts. These principles say that an unreasonable pre-estimate of loss would be an unenforceable fine. Since the deposit on the sale of land is an exception to this rule then, unless the case is "special" or "exceptional", defaulting buyers can expect to lose their deposit.

In summary, buyers and sellers should be aware of the following:-

1. If you default on the purchase of a property then the seller will almost certainly forfeit the deposit and in all likelihood will be entitled to keep the same unless there are special or exceptional circumstances. Even if the seller can sell the property elsewhere for more than the original price (which is most unlikely these days), this will not entitle the buyer to the return of the deposit.
2. If you have paid a deposit which is less than the amount stated in the contract (usually 10%), then it may well be the case that the contract also provides that the seller can demand the full amount of the 10% of the purchase price in the event of default.
3. The seller may well be able to claim additional costs, expenses and losses arising from the default, which may be in addition to the amount of the deposit forfeited.

If you have any doubts or concerns about your rights, obligations or entitlement under a contract for the sale or purchase of land then you should always seek professional legal advice.

Linder Myers Commercial Property Team specialises in contracts for the sale and purchase of land and regularly deals with these kinds of issues.

19 MAY 2009

For further information on Linder Myers expertise in dealing with the issues raised in this article please contact:

IVAN RANSON, PARTNER
COMMERCIAL PROPERTY DEPT
0161 837 6810
ivan.ranson@lindermyers.co.uk