Does a failure to complete justify forfeiture of a deposit?

 

When a contract for the sale of property falls through, the normal expectation is that where the fault lies with the buyer, the deposit paid on exchange of contracts will be forfeited. However, the Court is given a wide discretion to order the return of the deposit to the buyer. The precise extent of that discretion has been tested very recently in a judgment of the High Court (Midill (97PL) Limited v Park Lane Estates Limited & Anor [2008] EWHC 18 (Ch).

Background

On Christmas Eve 2005, the Claimant (“Midill”) agreed to pay the Second Defendant (“Gomba”) £4,000,000 for all the shares in the First Defendant (“Park Lane”) a company whose only asset was a commercial property in London. The price was to be paid in tranches including a 10% deposit upon execution of the agreement. Subsequently Midill was unable to complete notwithstanding service of a Notice to Complete. Thereafter Gomba sought to rescind the agreement and the property was subsequently sold by Park Lane to an unconnected company for a sum in excess of the original purchase price agreed.

Part of the dispute before the Court was to determine whether Gomba was entitled to forfeit the deposit paid by Midill upon exchange irrespective of the profit which had been achieved as a result of the subsequent sale of the property to an alternative third party.

The law on this issue is contained in Section 49(2) of the Law of Property Act 1925 which states:

“Where the Court refuses to grant specific performance of a contract, or in any action for the return of a deposit, the Court may, if it thinks fit, order the repayment of any deposit”.

This provision gives the Court an unqualified discretion to order the return of a deposit even if the buyer has failed to complete the purchase following service of a Notice to Complete. The question for the Court was how is that discretion to be exercised?

Position prior to the Midill case

The approach of the Court when exercising its discretion has been varied. In the late 1970’s the Court declared that the jurisdiction of Section 49(2) is “one to be exercised where the justice of the case requires”. The word “justice” was interpreted in a very wide sense, indicating that repayment must be ordered in any circumstances which makes this the fairest course between the parties. (Universal Corporation v Five Ways Properties Limited [1979] 1 ALL ER 553). In the 1980s there then followed several decisions of the Court which indicated that in circumstances where a seller was able to resell at a profit the fairest course was to order repayment. However, in 2001 the case of Omar v El-Wakil brought about a significant change of position.

In that case the Court of Appeal applied what has later been described as “a slightly stricter” approach. The importance of attaching certainty to the consequences of paying a deposit was recognised and, in a victory for sellers, it was held that if a buyer pays a deposit he is likely to lose it if he does not fulfil the contract; that should be the starting point. Indeed, the Court even went so far as to state that the circumstances which make it appropriate for the Court to exercise its discretion to return the deposit to the buyer must be exceptional. In Omar the deposit was not 10% but 31% and it was acknowledged by the Court that the property might be re-sold for a profit; yet the Court still did not order repayment.

The most recent guidance from the Court prior to Midill came in 2003 in the case of Tennero Limited v Majorarch Limited [2003 EWHC 2601] (“Tennero”) in which Goodman Derrick LLP acted for the Defendant, Majorarch Limited. In this case, the Court was asked to determine whether the deposits paid on three related transactions, the sale and purchase of three luxurious flats, should be returned. In a departure from the Omar case, the Court held on this occasion that if special circumstances are needed to justify the return of a deposit where the buyer is in breach of contract, the fact that the seller has or would be able to resell the property elsewhere for a profit would constitute such special circumstances. The Court was so persuaded by the valuation evidence available at the hearing that it concluded that the deposits on the two flats which were clearly capable of resale at a profit were in principle repayable notwithstanding the buyer’s default. Conversely, the seller was entitled to retain the deposit for the remaining flat for which the valuation evidence demonstrated that the sale price had declined.

The message from the Court following Tennero was therefore that the resale value of a property is a highly persuasive factor in determining the Court’s discretion whether to allow a deposit to be forfeited. Understandably, practitioners could have been forgiven for assuming as a result of this case that where a profitable re-sale had occurred or was likely, the deposit would in all likelihood have to be returned irrespective of the buyer’s default. However, the Court in Midill has confirmed that this is not so.

The Midill case

Midill had argued that the circumstances of its case fitted fairly and squarely within the principles enunciated by the Court in Tennero. The seller had resold the property elsewhere for a profit and therefore the deposit should be returned. However, the Court rejected that argument. In a departure from Tennero the Court did not order repayment of the deposit notwithstanding the fact that the seller had made a profit on a subsequent sale to an alternative buyer. The Judge’s view was that if the position were otherwise and the liability to repay a deposit were to depend upon some future sale price, there would be considerable uncertainty.

That is precisely what the notion of a fixed deposit was intended to avoid. The Court was also influenced by the fact that the parties were sophisticated professionals and therefore well aware of the risks involved in failing to complete a deal, although that fact would equally have applied to the parties in Tennero.

In my view, this case is a marked departure from the previous flexibility of approach which the Court was willing to adopt in exercising its discretion whether to order the repayment of a deposit. It is clear that on this occasion the Court was less willing to be influenced by market values and market conditions and was heavily influenced by the desire to achieve certainty in a contractual relationship. As a result, future buyers will in all likelihood find it difficult to contend that a profitable resale following a breach of contract is itself sufficient to warrant the return of their deposit. At least for now, sellers will breathe a sigh of relief.

Can the provisions of Section 49(2) of the Law of Property Act 1925 be avoided?

In the Midill case it was suggested by the Court that the parties could have expressly provided, in the contract, had they so wished, for the liability to repay the deposit in the event of a default to depend upon the outcome of a subsequent resale. However, it is probably unlikely from a seller’s perspective that this would be an acceptable point of negotiation.

Ideally the seller would probably prefer to seek to exclude the ability of the buyer to invoke Section 49(2) altogether. Would that be possible? In my view, the answer to this is “no” following the recent judgment of Aribisala v St James Homes (Grosvenor Doc) Limited [2007].

In July 2006, contracts were exchanged for the sale of two leasehold properties for a purchase price of £2.16m. A 10% deposit was paid on exchange. The contract stipulated that “Section 49(2) of the Law of Property Act 1925 shall not apply”. The buyer failed to complete and a Notice to Complete was served. The deposit was thereafter forfeited and a claim for repayment instigated. The seller sought to rely on the contractual exclusion of section 49(2) to defend the claim. The Court faced with this situation firmly held that a provision excluding the Court’s ability to exercise its discretion was effectively an attempt to remove the jurisdiction of the Court which was void on the grounds of public policy. Accordingly the provision in the sale contract was of no effect and could not exclude the buyer’s right to apply to Court for relief.

Deborah Rider acted for Majorarch Limited in the case of Tennero Limited v Majorarch Limited [2003 EWHC 2601].

Deborah Rider
Goodman Derrick LLP