What Happens to the Deposit Where A Buyer Fails to Complete the Purchase?
This blog shouldn’t be construed as legal advice. It is intended to provide general information. Please consult a lawyer if you need legal assistance.
Are you buying a new house? Whenever a buyer makes an offer for the purchase of a real estate property, the agreement for the purchase/sale provides for a deposit. While there is no fixed amount of deposit required by law, in Toronto 5 to 10 percent of the purchase price is usually seen as acceptable deposit amount. The deposit is applied to the buyer’s closing costs and will form part of the final purchase price.
A deposit serves two purposes. Absent a deposit, a buyer who is having a second thought about the purchase may decide to pull out of the deal, as the risk of a lawsuit from the seller may be minor. The deposit is also a sign of good faith, an indication that the buyer will pay the rest of the purchase price and complete the deal when the time comes.
The law regarding deposits and forfeiture is well settled.
Where a deposit is paid by the buyer in a contract for the purchase of land, and the purchase does not close because of a default by the buyer, the seller is entitled to retain the deposit without having to prove actual damages.1 Even in the case where the seller resells at a purchase price that is high enough to compensate him for any loss from the first sale, the seller may nevertheless keep the deposit.2 In Tang v. Zhang3 (“Tang”), an important case cited by the Ontario Court of Appeal in its recent decision in Redstone Enterprises Ltd. v. Simple Technology Inc.4 (“Redstone”), the Court observed:
“A true deposit is an ancient invention of the law designed to motivate contracting parties to carry through with their bargains. Consistent with its purpose, a deposit is generally forfeited by a buyer who repudiates the contract, and is not dependant on proof of damages by the other party. If the contract is performed, the deposit is applied to the purchase price.
The deposit constitutes an exception to the usual rule that a sum subject to forfeiture on the breach of a contract is an unlawful penalty unless it represents a genuine pre-estimate of damages. However, where the deposit is of such an amount that the seller’s retention of it would be penal or unconscionable, the court may relieve against forfeiture….” 5
As evident in the above excerpt from the decision in Tang, courts have the discretionary power to grant relief against forfeiture. In Ontario, the courts can grant this equitable pursuant to 98 of the Courts of Justice Act.6
In Varajao v. Azish7, the Ontario Court of Appeal upheld the view that to obtain relief from forfeiture the buyers will be required to establish that (a) the forfeited sum was out of proportion to the damages suffered; and (b) it would be unconscionable for the vendor to retain the money. However, this is not an easy threshold to meet. In Redstone the Court of Appeal for Ontario pointed out that “the finding of unconscionability must be an exceptional one, strongly compelled on the facts of the case”.8 The Ontario Court of Appeal observed that in some cases unconscionability may be established purely on the basis of disproportionality between the damages suffered and the amount forfeited. When this would not be the case, the court will consider other indicia of unconscionability such as inequality of bargaining power, a substantially unfair bargain, the relative sophistication of the parties, the existence of bona fide negotiations, the nature of the relationship between the parties, the gravity of the breach, and the conduct of the parties.9
Is all money paid prior to completion is considered a deposit?
In Tang, Madam Justice Newbury rejected the argument that simply labelling a payment as a deposit means that the court’s power to relieve from forfeiture is lost. Madam Justice Newbury observed that on a general level, the question of whether a deposit or other payment made to a seller in advance of the completion of a purchase is forfeited to the seller when the buyer walks out of the agreement, is a matter of contractual intention.10
Generally, earnest money paid prior to the completion of a contract (particularly if the amount is equal to or less than 10 percent of the contract price) has been considered to be a true deposit. However, this really depends on the wording of an agreement of purchase/sale. For example, where the wording of an agreement provides that the deposit is liquidated damages, a seller may be prohibited from seeking additional damages. This is why agreements often contain a clause which provides that the deposit will be absolutely forfeited to the seller and the seller may claim additional damages. In other cases, again depending on the wording of the agreement, a party may be able the claim the deposit and claim damages that exceed the deposit. Therefore a careful review of the agreement of purchase/sale is especially important for both the buyer and the seller.
While an avenue for obtaining equitable relief against forfeiture remains available, a buyer who decides to walk away from an agreement should not take the risks lightly. They may be risking more than just the deposit. The seller may claim the difference in the value of the property from the contract price as well as other losses and expenses that they have suffered. These claims may include closing costs incurred for the failed transaction, moving and storage costs, additional property or rental costs, interest and professional fees such as a realtor’s fees due or lost as a result of the breach.
Seller has the obligation to mitigate
It is worth mentioning that a seller cannot just rest and wait for a court to grant remedy. The seller has a duty to mitigate or minimize his losses and may need to work diligently to sell the property. If the Court finds that the seller hasn’t properly mitigated his or her losses, they may not be awarded full damages.
How can you minimize your risks?
Given the significant risk that the buyer may be faced with, it is critical that the buyer considers a few things prior to firming up on their purchase. For example, making an agreement conditional upon securing sufficient financing, home inspection, review of the agreement by a lawyer or status certificate review (for condominiums) is a good idea. If one of the conditions remains unresolved during the conditional period they can back out of the deal and seek their deposit back. The buyer may also want to keep the deposit small to minimize your loss if you can’t go through with the deal. Conversely, if you are the seller, consider insisting on an appropriate deposit before you enter into an agreement of purchase/sale.
Consider consulting your lawyer if you need help with writing up your agreement, or if your real estate deal does not go as planned.
1. Agrette, et al. v Sacco, et al., 2016 ONSC 617 (CanLII), at paragraph 48.
2. ibid.
3. 2013 BCCA 52 (CanLII), 359 D.L.R. (4th) 104.
4. 2017 ONCA 282 (CanLII).
5. Redstone, at paragraph 20.
6. RSO 1990, c C.43.
7. 2015 ONCA 218 (CanLII).
8. Redstone, at paragraph 25.
9. ibid, at paragraphs 29 and 30.
10. Tang, at paragraph 30.
11. Workers Trust & Merchant Bank Ltd v. Dojap Investments Ltd., [1993] A.C. 573 (P.C.); Tang.