Contracts for the sale of land in NSW can sometimes contain a special condition which allows the deposit to be released to the vendor prior to completion of the contract. This type of special condition is called a “release of deposit” clause.

Before agreeing to any release of deposit clause, purchasers should carefully consider the significant legal risks that are involved in allowing a deposit to be released before settlement. There are also important considerations for vendors when relying on a purchaser’s funds to pay for the vendor’s purchase of another property. This article outlines those risks to both purchasers and vendors and suggests some strategies to try to address them.

What is a Release of Deposit Clause?

Under the standard conditions in a contract for the sale and purchase of land in NSW, the deposit paid by the purchaser is to be kept by the agent or vendor’s solicitor in a trust account and not released to the vendor until settlement (or earlier if the contract is rescinded or terminated).  However, a release of deposit clause allows the vendor to use all or some of the deposit prior to settlement.

As a special condition, there is no standard drafting of a release of deposit clause. What the vendor is allowed to do with the money, and any conditions regarding the release, will depend on how the clause has been drafted by the vendor’s solicitor or conveyancer.

Often, the purpose of a release of deposit clause is to allow the vendor to pay for their own deposit on their purchase of another property, or to secure residential aged care accommodation prior to settlement. However, depending on its drafting the clause can also extend to payment of stamp duty, land tax, or for other purposes.

What is the issue with agreeing to A release of deposit?

While the primary purpose of a deposit is to show that the purchaser ‘means business’ about honouring the contract and to provide security to the vendor, the safekeeping of the deposit in a trust account also serves as security to the purchaser that the deposit will be available to be returned if the purchaser is entitled to rescind or terminate the contract.

A purchaser who agrees to the release of deposit carries a significant risk that the funds cannot be recovered if the vendor does not complete the contract, or if the purchaser is entitled to rescind the contract.  

If the vendor is buying another property and the contract for the vendor’s purchaser of that property also allows for the release of deposit, then the deposit can hypothetically be released and used as security in several other property transactions.

Some examples of the issues that can arise in practice include the following:

No funds available to return deposit

If the purchaser is entitled to rescind the contract, there may be significant practical difficulties in seeking to recover the funds if they have been released.

For instance, imagine the following hypothetical: Amber has been saving for a deposit on a property for years. She finally finds the perfect Sydney property and signs a contract and pays a deposit to purchase the property from Bob. Immediately after exchange, Bob uses Amber’s deposit funds to pay a deposit to purchase Cindy’s property. Cindy in turn uses the funds as a deposit to purchase a property from David.

If Amber becomes entitled to rescind the contract (for instance, because of an undisclosed road-widening affecting the property), she will be in a position where her deposit has been released several times over. Unless Bob is willing to and has other funds to pay Amber, Amber may have to go through a costly and stressful exercise of taking Bob to Court to have any hope of recovering the deposit. She will also have to hope that at the end of the day Bob has enough equity in the property or other assets to satisfy a judgment against him.

Vendor‘s Mortgage

Purchasers may take it for granted that a vendor will be able to complete the sale. However, in a distressed sale, if the vendor owes more on their mortgage (or mortgages) than the funds the vendor will receive from the sale of the property on settlement, the vendor may be unable to discharge the mortgage. They will not be able to give you legal title of the property unless the bank’s mortgage is discharged.

In those circumstances, the vendor would also presumably be unable to then pay for their purchase of another property, risking that their deposit paid in that matter is forfeited to the vendor in that other transaction.

vendor becomes bankrupt

If the vendor becomes bankrupt before settlement, your entitlement to the deposit will be treated as an unsecured creditor. Your unsecured debt (your interest in the deposit) would be down the pecking order with secured creditors (e.g. a registered mortgagee), and the costs of the bankruptcy trustee, being paid in priority to you.

Dispute resolution

The ‘quarantining’ of the deposit in a trust account pending settlement can help the purchaser satisfactory resolve disputes that can arise prior to settlement. For example, if there is rubbish left or damage to the property that was not present at the time the contract was entered into, the purchaser may seek that an appropriate sum of money be retained in trust until the vendor fixes the damage.

The premature release of the deposit can deny the purchaser this tactical advantage if any disputes arise.

What are some steps purchasers can take regarding a release of deposit clause in NSW?

Ideally, a purchaser should seek that the release of deposit clause be deleted from the contract before it is signed. However, some vendors will insist on their ability to use the deposit prior to settlement. In that case, the purchaser can consider the following measures, before signing the contract, to try to limit their exposure to risk relating to a release of deposit clause:

• Request written confirmation and evidence that after the release of the deposit, the vendor has the financial capacity to discharge their mortgage on settlement.

• Require that the funds may only be released into the trust account of a real estate agent or solicitor/conveyancer and not further released unless the purchaser gives prior written consent. The release of deposit clause should not allow for payments other than a deposit on the purchase of another property (for example, not for the payment of stamp duty or land tax).

• Require that the vendor must give prior notice of the proposed release of deposit including details of the amount to be released and of the transaction to which the proposed release relates (e.g. details of the property, etc).

• Register a caveat on the title of the property immediately following exchange of contracts. This will prevent the registration of any further mortgage or the transfer of the property. If any dispute arises and you are entitled to the return of the deposit, you could maintain the caveat until your deposit is repaid.

A less expensive option which provides similar protection to a caveat is to register a priority notice. However, a priority notice will expire after 60 days, but can be extended to 90 days. If a purchaser registers a priority notice but it later becomes necessary to register a caveat (for example, if there is a protracted dispute and the priority notice is due to expire), there is a risk that by that time the caveat is registered it may be lower in priority to a caveat or other interest registered before your caveat.

You should seek legal advice having regard to the specific circumstances of your matter before lodging or maintaining any caveat or priority notice.

Does a release of deposit clause pose any risks to a vendor?

A release of deposit clause can be a useful tool allowing a vendor to access deposit funds before they would otherwise be entitled under the Contract. While a release of deposit clause itself does not create risks to the vendor, a vendor who intends to rely on the proceeds from their sale to complete their purchase of another property risks that their sale falls through while remaining bound to their purchase contract.

dependence on the purchaser

Unless a vendor has sufficient other liquid funds or bridging finance, the vendor is at the mercy of the purchaser completing the contract for the vendor to then be able to fund their purchase of the other property. If the purchaser fails to complete the contract, the vendor would also risk not completing their own purchase contract, with the likely result that they will forfeit the deposit and may be sued for any loss on the subsequent sale of the property.

Rescission of the contract by the purchaser

A vendor also risks that the purchaser may be entitled to rescind the contract, for example, due to the inadvertent non-disclosure in their sale contract of a matter which entitles the purchaser to rescind.

If the purchaser rescinds the contract, the vendor must refund the deposit in full. The vendor will also probably forfeit the deposit on their proposed purchase, as they will not be in a position to complete that contract, and may be sued for any shortfall on the subsequent sale of the property. In addition, the vendor may still be liable to pay the agent’s commission, even though the sale did not proceed. Whether commission is payable will depend on the terms of the agency agreement with the real estate agent.

Alternatives to relying on the release of deposit clause

Due to the potential issues that can arise, a vendor should consider waiting until their own sale has been finalised before entering into a contract for the purchase of another property.

A vendor who is eager to secure a purchase of another property prior to completion of their own sale can consider entering into a call option agreement rather than a contract for purchase.  The vendor would then only exercise the option once their own sale has completed. This would mean that if the vendor’s sale of their property does not proceed, the vendor would only lose the option fee paid at the time of making the agreement, rather than the whole deposit and liability for loss on the subsequent sale of the property. In a hot property market, it may be difficult to negotiate an option agreement as the vendor of the other property would likely prefer a standard sale contract.

Before agreeing to or relying on a release of deposit clause, you should seek legal advice tailored to your circumstances. Gattuso Legal is experienced with Sydney conveyancing and can help you with all aspects of the conveyancing process.  For assistance with your conveyancing matter, leave us a message or telephone us on (02) 9698 9160.

Disclaimer

The information in this article is a general overview and for educational purposes only.  Each contract and transaction is unique and professional legal advice should be sought for your specific circumstances. Refer to our website terms of use for further details of our disclaimer.