Defaulting Purchasers Lose their Deposits, Even in Rising Real Estate Markets

One of the fundamental principles of contract law is that damages are based on the actual loss suffered by the innocent party when there is a breach of contract.  Damages restore the innocent party to the position she would have been in if the contract had been fulfilled.   However, she is required to seek alternatives to mitigate her loss.  If there is no actual loss, because the innocent party can re-contract at the same or a better price, no damages are awarded.  The traditional exception to this rule has been in real estate deals, where a purchaser who backs out loses his deposit regardless.  

This doctrine was questioned recently in British Columbia, the land of upward spiralling real estate prices.    In the case of Tang v Zhang, 2013 BCCA 52 [Tang, BCCA], a special five judge panel re-affirmed the traditional principle.  It held that the vendor was entitled to keep a substantial deposit, even though he was able to re-sell the property at an even higher price, and suffered no damages.

Conflicting Interpretations Based on Contract Language

The purchaser had put down a $100,000 deposit on a $2 million residential property.   He failed to complete the transaction, but asked to get the deposit back after the vendor re-sold the property at a higher price.   He was successful at the lower court, Tang v Zhang, 2012 BCSC 214 [Tang, BCSC].   Here, the lower court relied on an earlier appeal court decision, which appeared to suggest that the issue hinged on the wording of the contract.   It held that the contract had to state very clearly that the deposit was non-refundable, which was found not to be the case here.

The Court of Appeal overruled any perception that the particular wording in the standard form contract should affect the outcome.  Indeed, the view propounded was that the wording had to be understood in terms of the historic jurisprudence related to real estate deposits.   For more than 100 years in Anglo-Canadian law, they have been non-refundable:

[A deposit] is “non-refundable” by definition, and that “absolutely” as a qualifier of “non-refundable” does not add anything except emphasis. To this extent, it was perhaps unnecessary for this court in Williamson to rely on the phrase “absolutely non-refundable” to support the conclusion that the deposit in that case was forfeited by the defaulting buyer. This is not a “presumption”, … but simply a matter of definition — the interpretation of a word used in a contract in light of its meaning at common law  (Tang, BCCA, para 25).

Why Are Real Estate Deposits Different?

The general principle in contract law is that penalty clauses are unenforceable.  The seller can keep the defaulting buyer’s deposit only when it is a reasonable estimate of liquidated damages.  When there are obviously no damages occasioned by the breach, a significant deposit cannot be kept.  The contract cannot displace judicial discretion in calculating the damages.  This was enunciated by Laskin CJC in HF Clarke Limited v Thermidaire Corp Ltd, [1976] 1 SCR 319 [HF Clarke]:

The primary concern in breach of contract cases … is compensation, and judicial interference with the enforcement of what the courts regard as penalty clauses is simply a manifestation of a concern for fairness and reasonableness, rising above contractual stipulation…. It is always open to the parties to make the predetermination, but it must yield to judicial appraisal of its reasonableness in the circumstances  (HF Clarke, p 331).

By contrast, the position with regard to real estate deposits is that they are non-refundable except in situations where the deposit is so large as to be unconscionable.   That is not precisely defined, but it is generally held that a deposit of 10 percent is not unreasonable, and in the case at bar the deposit was only 5 percent of the purchase price.  

This is widely regarded as the law in Ontario as well, as in the recent case of  Pleasant Developments Inc. v Iyer, 2006 CanLII 10223 (ON SCDC).   As in Tang, the seller suffered no damage, and a Small Claims Court judge ordered $9,700 of a $10,000 deposit to be refunded.  The seller successfully appealed, and kept the whole deposit.

A UK Precedent from 1884 is Still the Law in Canada

It is noteworthy that the BC Court of Appeal, in reversing the lower court decision to refund Mr. Zhang’s deposit, relied entirely on the authority of a Victorian era decision from the UK.   This decision itself offered no clearly defined rationale:

The seminal authority on the nature of a deposit is the English Court of Appeal’s decision in Howe v. Smith (1884) 27 Ch. D. 89. It concerned an agreement to purchase premises for a price of £12,500. The buyer paid £500 “as a deposit and in part payment of the purchase money”, but failed to complete on the specified date and on an extended date…. Each member of the Court delivered separate reasons for holding that the deposit was forfeited by (or not refundable to) the buyer  (paras 19-20).

Lord Justice Fry’s judgment is generally regarded as the leading one in Howe v. Smith. He traced the practice of a contracting party’s giving something to the other party to signify the conclusion of the bargain, as dating at least from Roman law and then passing to the early jurisprudence of England. (At 101-02.) Under that law, the “earnest” or deposit was lost by the party who failed to perform the contract. In Fry L.J.’s words, a deposit was “not merely a part payment, but is then also an earnest to bind the bargain so entered into, and creates by the fear of its forfeiture a motive in the payer to perform the rest of the contract”  (para 22).

The BC Court of Appeal went on to cite a more recent Privy Council decision, on an appeal from Jamaica, that re-affirmed Howe v Smith, for deposits up to 10 percent:

In Workers Trust & Merchant Bank Ltd v. Dojap Investments Ltd. [1993] 2 All E.R. 370, [1993] 2 W.L.R. 202, Lord Browne-Wilkinson stated:   “In general, a contractual provision which requires one party in the event of his breach of the contract to pay or forfeit a sum of money to the other party is unlawful as being a penalty, unless such provision can be justified as being a payment of liquidated damages, being a genuine pre-estimate of the loss which the innocent party will incur by reason of the breach. One exception to this general rule is the provision for the payment of a deposit by the purchaser on a contract for the sale of land. Ancient law has established that the forfeiture of such a deposit (customarily 10% of the contract price) does not fall within the general rule and can be validly forfeited even though the amount of the deposit bears no reference to the anticipated loss to the vendor flowing from the breach of contract”  (para 24).

While accepting the doctrine of Howe v Smith, in Dojap the Privy Council actually ordered the whole deposit to be returned.  A deposit of 25 percent had been taken, which was held to be excessive, and thus an unenforceable penalty clause.

The Supreme Court of Canada Has No Clear Position

The BC Court of Appeal went on to suggest that “Howe v. Smith has been adopted by the Supreme Court of Canada” (at para 24).   However, a look at the few very old Supreme Court cases that they cited indicates an ambiguous adherence to the principle.   The clearest rationale for the doctrine stated by the Supreme Court is in HW Liebig Co v Leading Investments Ltd, [1986] 1 SCR 70 [Liebig]:

[T]hat deposit in ordinary circumstances belongs to the vendor. It is recompense to him for the fact that his property was taken off the market for a time as well as for his loss of bargaining power resulting from the revelation of an amount that he would be prepared to accept  (Liebig, para 33).

This rationale speaks of “recompense,” which suggests that it is based on the presumption of damage suffered by the vendor.  If the breach of contract by the purchaser results in only a small delay in the property being sold, and no financial loss to the vendor, it is hard to argue that it can justify the forfeit of the whole of a substantial deposit.

It should be noted that Liebig involved a dispute between the vendor and the real estate agent over which of the two would keep the deposit, and the defaulting buyer was not a party to the dispute.  There has not actually been an SCC decision on the specific issue of justifying the forfeiture of the deposit in an ordinary real estate transaction since 1914, Snell v Brickles, (1914) 49 SCR 360.  There, the SCC ordered the bulk of the deposit to be returned (because the buyer’s default was unintentional, due to illness).

Is there really something so sacred about real estate transactions that makes these bargains more inviolable than other contracts?   These are the largest contracts that most ordinary people enter into.  A buyer may be forced to back out of a deal due to an unanticipated event beyond his control.  The seller is at some risk, if the property is taken off the market for a significant period of time, and so it makes sense to require a deposit in case there is damage, as something analogous to security for costs.   However, if damage fails to occur in spite of the breach, because the seller can quickly sell the property for even more in a rising market, it is hard to justify keeping a deposit of $100,000 or so.  

This is an issue that somebody ought to appeal to the Supreme Court of Canada.   The Supreme Court in recent years has changed one traditional rule of real estate law, by restricting access to specific performance, as stated in Semelhago v Paramadevan, [1996] 2 SCR 415.   If the defaulting seller can only be sanctioned based on actual damages, reciprocity suggests that a defaulting buyer should receive the same treatment.  It might be time to review whether ancient precedents from the days of quill pens are still appropriate for modern conditions where houses are sold through on-line databases.