Gardner Leader

Stuart Durrant, Conveyancing Partner at Gardner Leader LLP, explains the true meaning of a deposit and its consequential loss should you default on the purchase of a property.

One of the most common misunderstandings I come across when I meet clients is the meaning of the deposit they will pay on exchange of contracts as part payment towards the purchase price. Traditionally this sum has been 10% but recently a 5% deposit or less has become quite common.

It is generally thought that the deposit is the difference between the mortgage and the purchase price. This is strictly not correct. It is any sum that is agreed as the contractual deposit paid by the buyer on exchange of contracts and reassures the seller that, if the buyer were to withdraw, there is a sizeable sum of money available to compensate for any loss.

It is also worth pointing out that it is a very common provision in contracts for the sale of property to have a clause saying that if less than 10% is actually paid as a deposit on exchange of contracts then, if the buyer defaults, the full 10% becomes payable.

Generally in Contract Law, requiring a contracting party to forfeit a deposit of 10% if they default on the agreement would be regarded as an unenforceable ‘penalty’ (being a harsh or unusual punishment). However, it is long established that deposits on the sale of land or property should be seen as an exception to this general rule.

As such, the seller’s ability to keep the deposit of a defaulting buyer is a contractual entitlement. The Courts may order the repayment of the deposit if they think fit but, in practice, this discretion will rarely be exercised - only in ‘exceptional circumstances’. This was made clear in a case called Omar which concluded that:

“In a situation where a purchaser could not himself perform, the circumstances which make it appropriate for the court to exercise its discretion in his favour must be exceptional. Inability to complete is exactly the risk the deposit was intended to guard against”

This view was followed by the Court of Appeal last year in a case which involved a £400,000 deposit on a £4m transaction. The trial judge saw nothing ‘exceptional’ in the circumstances of the case and ordered the defaulting buyer to pay the deposit. The Court of Appeal agreed. It noted that the sale of the property at a higher price at a later date (so making a windfall profit for the seller) would not be regarded as ‘exceptional’, and that there was no obvious reason why the original buyer who had defaulted should receive any benefit from such a price rise.

The court took the view that the seller had borne the risk and cost of holding the property during the intervening period and accordingly any profit should accrue to him. What is more, the court made it clear that it strongly favoured having certainty in respect of a well-established and well-known contractual agreement. In simple terms, there really will need to be ‘exceptional circumstances’ to justify a defaulting buyer being able to recover his deposit. Certainly, an inability to obtain a mortgage in the current economic climate would not be sufficient.

So, if a buyer defaults, the seller is legally entitled to keep the deposit and furthermore, the seller is also entitled to claim damages for the losses arising (and, in a falling market, the decline in property values may well exceed the amount of the deposit).

In conclusion, when you pay a deposit and exchange contracts, this is a serious commitment which can have dire financial consequences if you are unable to fulfil your contractual obligations.