The standard New South Wales contract for the sale of property requires the purchaser to pay a 10% deposit at the time the contract is made. However, it has become common for vendors to accept payment of an initial 5% deposit. This practice usually includes inserting a special condition into the contract in which the vendor asserts that the payment of the deposit made on exchange of contract is the first of two or more instalments of the ‘10% deposit’. Depending on the drafting of the special condition and the circumstances of the transaction, the further instalments of the ‘deposit’ may not actually be considered a deposit at law and may not be recoverable by a vendor if the contract is not completed.

Contract Law & the Rule Against Penalties

In general, a clause of contract which requires a party who breaches the contract to pay an amount of money will be unenforceable as a penalty unless the amount to be paid can be justified as being a genuine pre-estimate of the loss the innocent party will suffer because of the breach. This is often referred to as the ‘rule against penalties’.

However, a deposit under a contract for the sale of land is an exception to the general rule against penalties. A vendor is entitled to keep a forfeited deposit even though the amount of the deposit may not have any relation to the loss the vendor may suffer because of the breach. To be covered by this exception, the deposit must be reasonable in amount.

Generally, a 10% deposit has been treated under NSW as being reasonable under a contract for the sale of land (see, for example, the judgment of Bryson JA (with whom Handley and McColl JJA agreed) in Luu v Sovereign Developments Pty Ltd [2006] NSWCA 40 at [24]).

Deposits must be an ‘earnest for performance’

To have the benefit of the exception to the rule against penalties afforded to deposits, the amount being sought to be forfeited as a deposit must have the legal characteristics of a deposit. Otherwise, it will not be considered a deposit. Courts have held that a deposit must be an ‘earnest of performance’, or in other words, a demonstration that the purchaser is committed to completing the purchase.

If the payment becomes due because of the purchaser’s breach of the contract, then it will be a penalty. This is because the payment cannot be characterised as an ‘earnest for performance’ when it is paid because of the purchaser’s breach of the contract.

Case example: Boyarsky v Taylor

In Boyarsky v Taylor [2008] NSWSC 1415 at [48-50], the contract for sale included a special condition which made the payment of the second instalment of a deposit due on the “completion date”. The special condition did not include any express provision that the second instalment was to be paid if the purchaser was in breach of the contract. After the purchasers did not settle on the “completion date” the vendors commenced court proceedings seeking to hold the purchasers to the contract (‘specific performance’) and seeking the payment of the second instalment of the deposit. The Supreme Court of NSW constituted by Brereton J held that the vendors were not entitled to the second instalment of the claimed deposit because in substance the payment was only being sought by reason of the purchaser’s failure to complete the contract on the completion date. That is, the second instalment did not have the character of a deposit and was therefore not an exception to the rule against penalties. As the amount was not a genuine pre-estimate of the damage suffered, it was a penalty.

What choices do vendors have?

In view of the case law, vendors should approach any proposal to make a deposit payable by instalments with some caution. A vendor who agrees to a 5% deposit clause should be fully aware of the risks to be in a position to make an informed decision. Considerations might include whether a 5% deposit would be adequate to cover the loss that might be incurred if the purchaser fails to complete the contract, including the cost of agent’s commission which might be payable depending on the terms of the vendor’s agency agreement even if the sale is not completed. The options available to vendors would appear to be either of the following:

1. Always insist on 10% deposit payable at the time of making the contract. However, this may deter some prospective purchasers.
2. Agree to insert a special condition allowing for the payment of the deposit by instalments, with the timing of the further instalment(s) of the deposit to occur close to the date of contract relative to the date for completion. For example, where completion is due 42 days after the contract date, the second instalment of the deposit might be payable 5 business days after the contract date. For contracts with an extended settlement period, this payment schedule may be extended. However, the closer a payment is to the settlement date, the greater the risk the payment is not an earnest for performance.
3. Accede to a purchaser’s request that a second instalment of a ‘deposit’ be payable on or around the date of completion, in the full understanding that there is a real risk that if the purchaser fails to make payment the vendor may not be legally entitled to the unpaid instalment/s of the purported ‘deposit’. 

The choice will depend on the risk tolerance of the vendor and striking the right balance between commercial goals and risk. However, the vendors should be fully aware of the risks and potential benefits to be able to make an informed decision when considering a request for the payment of less than a 10% on exchange of contracts.

Other pitfalls which risk vendors losing a deposit

A purchaser can seek the return of a deposit paid in certain limited circumstances.

Section 55(2A) of the Conveyancing Act 1919 (NSW) provides the Court with the power to order the return of a deposit if it thinks fit to do so. Courts have interpreted this power quite widely, and greater than the Court’s equitable powers in relation to return of a deposit (Akrawe v Culjak [2023] NSWCA 171 at [100].

However, the purchaser still has to overcome quite a high hurdle in establishing that it is unjust and inequitable to permit the vendor to retain a deposit (see, for example, Lucas & Tait (Investments) Pty Ltd v Victoria Securities Ltd [1973] 2 NSWLR 268, at 272). Section 55 of the Conveyancing Act also provides for the return of the deposit where there is a defect in title in certain circumstances.

Alternatively, a purchaser may be entitled to rescind a contract and obtain a refund of a deposit in other circumstances, including:

• If the vendor has not included a prescribed document into the contract (in which case the purchaser only has 14 days to rescind or less if settlement is sooner than 14 days after the contract); or

• If the vendor has breached a warranty implied by section 52A(2)(b) of the Conveyancing Act. For the purchaser to pursue this option, they must show that they were unaware of the breach of warranty before entering into the contract, and that they would not have entered into the contract if they had known about it. The notice of rescission must be sent prior to settlement.

For assistance with any aspect of property contracts or conveyancing, please contact our office on (02) 9698 9160. Gattuso Legal is a legal practice in the Inner West of Sydney with experience in property law and conveyancing. Read more about Gattuso Legal’s conveyancing services.

The information in this article is a general overview and for educational purposes only. It does not cover all the nuances involved regarding deposits.  Each situation is unique and professional legal advice should be sought for specific circumstances. Refer to our website terms of use for further details.