Contract for sale — Deposit — Whether deposit in excess of 10% is a penalty or whether such deposit can be forfeited by the vendor
On October 5
1989 the appellant, Workers Trust & Merchant Bank Ltd, as second mortgagee,
sold premises at auction to the respondent, Dojap Investments Ltd at a price of
$J11,500,000. Clause 4 of the contract provided for the payment of a deposit of
25%, and a sum of $J2,875,000 was duly paid by the respondent to the
appellant’s solicitors. The contract provided that the reminder of the purchase
money should be paid within 14 days of the date of the auction whereupon the
appellant were to execute a transfer of the property to the respondent and
lodge such transfer for registration. Clause 15 of the contract provided that
time should be of the essence of all time-limits contained in the contract.
Clause 13 provided that if the purchaser should fail to observe or comply with
any of the foregoing stipulations on his part his deposit shall be forfeited to
the vendor who would be at liberty to resell the property. On the date fixed
for completion (October 19 1989) the respondent’s attorney sent to the appellant
a letter of undertaking from the Jamaica Citizens Bank Ltd to pay the balance
of the purchase price, subject to certain conditions. The appellant’s attorney
rejected this and gave the respondent 24 hours to provide a satisfactory
undertaking. On the respondent failing to provide a satisfactory undertaking,
on October 23 1989 the appellant wrote to the respondent rescinding the
contract and purporting to forfeit the deposit. The respondent refused to
accept this and on October 26 1989 tendered to the appellant the balance of the
purchase money with interest. The appellant returned the cheque the next day.
On November 24 1989 the respondent commenced proceedings claiming specific
performance or alternatively relief from forfeiture of the deposit. On June 25
1990 Zacca CJ rejected the respondent’s claim for specific performance and its
claim for return of the deposit. On appeal, the Jamaican Court of Appeal held
that the respondent was entitled to relief from forfeiture to the extent that
the deposit exceeded 10% of the price, but did not award any interest on that
sum. The appellant appealed against that decision; the respondent
cross-appealed claiming that it should have been awarded relief against
forfeiture as to the whole of the 25% deposit and should have been awarded
interest.
reasonable deposit has always been regarded as a guaranteed of performance as
well as a payment on account, and its forfeiture has never been regarded as a
penalty in English law or common English usage. In order to be reasonable a
true deposit must be objectively operating as ‘earnest money’ and not as a
penalty. The correct approach is to start from the position that, by
long-continued usage the customary deposit has been 10% and a vendor who seeks
to obtain a larger amount by way of forfeitable deposit must show special
circumstances which justify such a deposit. Notwithstanding the practice in
Jamaica of the vendor discharging the purchaser’s liability to transfer tax,
and therefore deposits in excess of 10% have become common to provide for this,
there was no need in the present case for such a high deposit because the tax
was not payable before
provision for its forfeiture was a plain penalty. As the appellant never
stipulated for a reasonable deposit of 10%, the whole 25% deposit constituted
an unreasonable sum and had to be repaid as a whole together with interest at
12% pa from the date of rescission until the date of actual payment. However,
the appellant is entitled to deduct the amount of any damages it has suffered
as a result of the respondent’s failure to complete from the purported deposit
of 25%.
The following
cases are referred to in this report.
Commissioner
of Public Works v Hills [1906] AC 368
Howe v Smith (1884) 27 ChD 89
Linggi
Plantations Ltd v Jagatheesan (1972) 1 MLJ
89
Stockloser
v Johnson [1954] 1 QB 476; [1954]2 WLR 439;
[1954] 1 AllER 639, CA
This was an
appeal by Workers Trust & Merchant Bank Ltd, from a decision of the Court
of Appeal of Jamaica which had allowed, in part, an appeal by Dojap Investments
Ltd, from a decision of Zacca CJ in proceedings for specific performance and
relief from forfeiture of a deposit.
Roald
Henriques QC and David Batts, of the Jamaican Bar, (instructed by Philip Conway
Thomas) appeared for the appellant; Richard Mahfood QC, of the Jamaican Bar,
and James Guthrie (instructed by Charles Russell) represented the respondent.
In delivery
the opinion of the Judicial Committee, LORD BROWNEWILKINSON said: This
case raises the question whether a deposit in excess of 10% paid under a
contract for sale of land can be lawfully forfeited by the vendor in the event
of a failure by the purchase to complete on the due date.
On October 5
1989 Workers Trust & Merchant Bank (‘the bank’) as second mortgagee sold
certain premises at auction to Dojap Investments (‘Dojap’) at a price of
$J11,500,000. Clause 4 of the contract provided for the payment of a deposit of
25% of the contract price and a deposit of $J2,875,000 was duly paid by Dojap
to the bank’s solicitors. The contract provided that the remainder of the
purchase money should be paid within 14 days of the date of the auction
whereupon the bank were to execute a transfer of the property to Dojap and
lodge such transfer for registration. Clause 15 of the contract provided that
time should be of the essence of all time-limits contained in the contract.
Clause 13 of the contract provided as follows:
13. If the
purchase shall fail to observe or comply with any of the foregoing stipulation
on his part his deposit shall be forfeited to the vendor who shall be at
liberty (without tendering any transfer) to re-sell the property either by
public auction or private contract at such time and in such manner and subject
to such conditions as the vendor may think fit and any deficiency in price
which may result on and all charges costs and expenses attending a re-sale or
attempted re-sale, together or rendered useless by such default, shall be made
good and paid by the defaulting purchaser at the present sale and be
recoverable from him by the vendor as liquidated damages. Any increase of price
on a re-sale shall belong to the vendor.
On the date
fixed for completion (October 19 1989) Dojap’s attorney, Mr Clough, sent to the
bank a letter of undertaking from the Jamaica Citizens Bank to pay the balance
of the purchase price, subject to certain conditions. The bank’s attorney, Miss
Eaton, rejected this and gave Dojap 24 hours to provide a satisfactory
undertaking. Dojap attempted to do so on October 20 1989, but the bank again
rejected it. On October 23, the bank wrote to Dojap rescinding the contract and
purporting to forfeit the deposit. Dojap refused to accept this, and on October
26 1989 tendered to the bank the balance of the purchase price with interest.
The bank returned the cheque the next day.
On November 24
1989 Dojap started proceedings claiming specific performance or alternatively
relief from forfeiture of the deposit. The case was heard by Zacca C J before
whom a number of different issues arose for decision on the claim for specific
performance. These are no longer in issue before the board. The judge gave
judgment on June 25 1990, rejecting Dojap’s claim for specific performance and
its claim for return of the deposit.
On November 12
1990 Dojap arranged to purchase the same piece of land from the first
mortgagee, Jamaica Citizens Bank, as a result of which the claim to specific
performance of the contract of the bank became largely academic. Dojap appealed
to the Court of Appeal, but did not pursue its claim for specific performance.
On Dojap’s alternative claim for relief from forfeiture and the return of the
deposit, the Court of Appeal (Rowe P, Forte J A and Downer J A) held that Dojap
was entitled to relief from forfeiture to the extent that the deposit exceeded
10% of the price but did not award any interest on that sum. The bank appeals
to the board against the decision of the Court of Appeal to give such relief
against forfeiture. Dojap cross-appeals claiming that it should have been
awarded relief against forfeiture as to the whole of the 25% deposit and should
also have been awarded interest.
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 damaged 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.
This exception
is anomalous and at least one textbook writer has been surprised that the
courts of equity ever countenanced it: see Farrand, Contract and
Conveyancing 4th ed p204. The special treatment afforded to such a deposit
derives from the ancient custom of providing an earnest for the performance of
a contract in the form giving either some physical token of earnest (such as a
ring) or earnest money. The history of the law of deposits can be traced to the
Roman law of arra, and possibly further back still: see Howe v
Smith (1884) 27 ChD 89 per Fry LJ at pp101-2. Ever since the
decision in Howe v Smith, the nature of such a deposit has been
settled in English law. Even in the absence of express contractual provision,
it is an earnest for the performance of the contract: in the event of
completion of the contract the deposit is applicable towards payment of the
purchase price; in the event of the purchaser’s failure to complete in
accordance with the terms of the contract, the deposit is forfeit, equity
having no power to relieve against such forfeiture.
However, the
special treatment afforded to deposits is plainly capable of being abused if
the parties to a contract, by attaching the label ‘deposit’ to any penalty,
could escape the general rule which renders penalties unenforceable. There are
two authorities which indicate that this cannot be done. In Stockloser v
Johnson [1954] 1 QB 476, Denning LJ in considering the power of the court
to relieve against forfeiture said, obiter, at p491:
Again,
suppose that a vendor of property, in lieu of the usual 10% deposit, stipulates
for an initial payment of 50% of the price as a deposit and part payment; and
later, when the purchaser fails to complete, the vendor resells the property at
a profit and in addition claims to forfeit the 50% deposit. Surely the court
will relieve again the forfeiture. The vendor cannot forestall this equity by
describing an extravagant sum as a deposit, any more than he can recover a
penalty by calling it liquidated damages.
In Linggi
Plantations Ltd v Jagatheesan (1972) 1 MLJ 89 Lord Hailsham
delivered the judgment of the board which upheld the claim to forfeit a normal
10% deposit even though the vendor had in fact suffered no loss. He referred on
a number of occasions to a requirement that the amount of a deposit should be
‘reasonable’ and said at p94:
It is also no
doubt possible that in a particular contract the parties may use language
normally appropriate to deposits properly so called and even to forfeiture
which turn out on investigation to be purely colourable and that in such a case
the real nature of the transaction might turn out to be the imposition of a
penalty, by purporting to render forfeit something which is in truth part
payment. This no doubt explains why in some cases the irrecoverable nature of a
deposit is qualified by the insertion of the adjective ‘reasonable’ before the
noun. But the truth is that a reasonable deposit has always been regarded as a
guarantee of performance as well as a payment on account, and its forfeiture
has never been regarded as a penalty in English law or common English usage.
In the view of
their lordships these passages accurately reflect the law. It is not possible
for the parties to attach the incidents of a deposit to the payment of a sum of
money unless such sum is reasonable as earnest money. The question therefore is
whether or not the deposit of 25% in this case was reasonable as being in line
with the traditional concept of earnest money or was in truth a penalty
intended to act in terrorem.
The Chief
Justice tested the question of ‘reasonableness’ by reference to the evidence
before him that it was of common occurrence for banks in Jamaica selling
property at auction to demand deposits of between 15% and 50%. He held that,
since this was a common practice, it was reasonable. Like the Court of Appeal,
their lordships are unable to accept this reasoning. In order to be reasonable
a true deposit must be objectively operating as ‘earnest money’ and not as a
penalty. To allow the test of reasonableness to depend upon the practice of one
class of vendor, which exercises considerable financial muscle, would be to
allow them to evade the law against penalties by adopting practices of their
own.
However,
although their lordships are satisfied that the practice of a limited class of
vendors cannot determine the reasonableness of a deposit, it is more difficult
to define what the test should be. Since a true deposit may take effect as a
penalty, albeit one permitted by law, it is hard to draw a line between a
reasonable permissible amount of penalty and an unreasonable, impermissible
penalty. In their lordships’ view the correct approach is to start from the
position that, without logic but by long continued usage both in the United
Kingdom and formerly in Jamaica, the customary deposit has been 10%. A vendor
who seeks to obtain a larger amount by way of forfeitable deposit must show
special circumstances which justify such a deposit.
As their lordships
understood from the submissions made in argument, formerly the normal practice
in Jamaica was to require a deposit of 10%. This was changed by the
introduction of a transfer tax by the Transfer Tax Act, 1971. Under that Act, a
transfer tax of 7.5% is payable on a transfer of land on sale. Although the tax
is ultimately payable by the transferor (section 3), under section 18 it is
collected from the transferee, ie the purchaser. As from April 3 1984, any
contract for the sale of land must contain a requirement for the payment of a
deposit of at least 7.5% and the purchaser is required to pay this sum to the
Commissioner of Stamp Duty and Transfer Tax: section 18(4). The purchaser is
entitled to recover from the vendor the amount of the tax so paid either by way
of deduction from the purchase price or by action: section 18(1).
Their
lordships were told that in practice this statutory machinery is not followed.
Since the tax has to be paid within 30 days of the date of contract (failing
which interest is payable by the vendor), a vendor is concerned to see that the
tax is paid promptly. Accordingly, what happens in practice is that the
contractual deposit is increased to at least 17.5% and is paid by the purchaser
to the vendor. The vendor then pays the tax. It is apparently this practice
that has caused the departure from the previously customary deposit of 10%.
If the
contract of sale in respect of which the transfer tax is payable is not in fact
completed, there is no liability to pay the tax: if such tax has been paid and
the contract goes off, the tax can be recovered by the vendor and, by virtue of
section 16(1), any amount so refunded ‘shall be dealt with according to the
rights of the parties to the contract (including any requirement of a deposit
implied therein under sub-section (4) of section 18)’.
Since in the
present case completion was supposed to take place within 14 days of the
contract, in the ordinary course completion would have taken place before the
transfer tax was due. Accordingly, there was strictly no need in the present
case for the bank to insist on the inclusion in the deposit of a sum equal to
7.5% of the contract price so as to be in pocket to pay the tax when it fell
due. However, the provisions as to the transfer tax are relevant. First, the
transfer tax provides the explanation for the departure from the customary 10%
deposit which was previously contracted for in Jamaica. Second, it illustrates
how unconscionable it would be for the vendor to forfeit the deposit to the extent
of 7.5% in the ordinary case. Where the tax has in fact been paid by the vendor
out of the deposit and then the sale goes off, the vendor would recover the tax
from the Revenue and then put the money in his own pocket.
In the present
case, the attorney for the bank in evidence sought to justify the amount of the
25% deposit in part by reference to the amount of the transfer tax which would
have been payable viz $J862,500. This evidence indicates that far from the
amount of the deposit having been fixed upon as a reasonable amount of earnest,
the amount was substantially influenced by fiscal considerations having nothing
to do with encouragement to perform the contract.
For the rest,
although the attorney for the bank gave evidence that the amount of the deposit
was fixed in part because it was a sum set ‘to ensure that persons do not bid
frivolously at the auction’ she also sought to justify the amount of the
deposit by reference to the payments that would have had to be made on
completion, ie tax, stamp duty, auction costs and auctioneer’s commission. She
accepted that the amount of the deposit was far in excess of what would have
been required to cover the maximum out of pocket expenses which would have
attended completion.
Their
lordships agree with the Court of Appeal that this evidence falls far short of
showing that it was reasonable to stipulate for a forfeitable deposit of 25% of
the purchase price or indeed any deposit in excess of 10%. As for the tax
element, the board do not suggest that it would be unreasonable for a vendor to
require advance payment of an amount sufficient to discharge the liability for
transfer tax on or before completion. But it does not follow that such advance
payment of tax should be capable of forfeiture if completion does not take
place: such tax is either not in the event payable or is recoverable by the
vendor. However, quite apart from the specific tax element in this case, there
is in the view of the board no sufficient evidence to justify a deposit of 25%
as being a true deposit.
The question
therefore arises whether the court has jurisdiction to relieve against the
express provision of the contract that the deposit of 25% was to be forfeited.
Although there is no doubt that the court will not order the payment of a sum contracted
for (but not yet paid) if satisfied that such sum is in reality a penalty, it
was submitted that the court could not order, by way of relief, the repayment
of sums already paid to the defendant in accordance with the terms of the
contract which, on breach, the contract provided should be forfeit. The basis
of this submission was the view expressed in a considered obiter dictum
of Romer LJ in Stockloser v Johnson (supra).
In that case
there was a contract for the sale of quarry machinery to the plaintiff, the
purchase price to be paid by instalments. The contract provided that in the
event of a default in payment of the instalments, the vendor could retake the
machinery and all instalments of the price previously paid should be forfeit.
Pursuant to the contract, the plaintiff took possession and used the machinery
but defaulted in payment of an instalment. The defendant forfeited the
instalments already paid. In the action, the plaintiff sought to recover the
instalments, alleging that their forfeiture was a penalty. The Court of Appeal
unanimously held that the forfeiture did not constitute a penalty on the facts
of that case but went on to express conflicting views, obiter, as to
whether, if the forfeiture had been a penalty, the court had jurisdiction to
order repayment. Somervell LJ and Denning LJ expressed the view that there was
such jurisdiction. Romer LJ held that there was no general right in equity to
mend the parties’ bargain and that, even where there was jurisdiction to
relieve from forfeiture, that could only be exercised by allowing a late
completion to a party who was in default in performance but willing and able to
carry out the terms of the contract belatedly.
Their
lordships do not find it necessary to decide which of those two views is
correct in a case where a party is seeking relief from forfeiture for breach of
contract to pay a price by instalments, the party in default having been let
into possession in the meantime. This is not such a case. In the view of their
lordships, since the 25% deposit was not a true deposit by way of earnest, the
provision for its forfeiture was a plain penalty. There is clear authority that
in a case of a sum paid by one party to another under the contract as security
for the performance of that contract, a provision for its forfeiture in the
event of non-performance is a penalty from which the court will give relief by
ordering repayment of the sum so paid, less any damage actually proved to have
been suffered as a result of non-completion: Commissioner of Public Works v
Hills [1906] AC 368. Accordingly, there is jurisdiction in the court to
order repayment of the 25% deposit.
The Court of
Appeal took a middle course by ordering the repayment of 15% out of the 25%
deposit, leaving the bank with its normal 10% deposit which it was entitled to
forfeit. Their lordships are unable to agree that this is the correct order.
The bank has contracted for a deposit consisting of one globular sum, being 25%
of the purchase price. If a deposit of 25% constitutes an unreasonable sum and
is not therefore a true deposit, it must be repaid as a whole. The bank has
never stipulated for a reasonable deposit of 10%: therefore it has no right to
such a limited payment. If it cannot establish that the whole sum was truly a deposit,
it has not contracted for a true deposit at all.
As to
interest, Downer JA in the Court of Appeal was under the misapprehension that
Dojap had never made any claim for interest: he indicated that if they had done
so he would have awarded 12% interest (being the rate provided in clause 5 of
the contract). It is clear
for Dojap before the Court of Appeal did claim such interest. Dojap is
therefore entitled to interest at 12% pa from the date of rescission until the
date of actual payment.
Finally, it
appears that the bank may have suffered some damage as a result of Dojap’s
failure to complete. If so, the bank is entitled to deduct the amount of such
damages from the ‘deposit’ of 25%. Such damage has not been quantified in the
judgment below but appears to be small in amount. It would not be right to keep
Dojap out of all its money to await the outcome of the necessary inquiry as to
damages. The bank ought accordingly to make immediate repayment of a
substantial amount of the deposit, leaving a fund out of which the bank’s
damages, if any, can be satisfied.
Their
lordships will therefore humbly advise Her Majesty that the appeal ought to be
dismissed and the cross-appeal allowed, and that the order of the Court of
Appeal should be varied so as to provide:
(1) an inquiry as to the damage (if any) suffered
by the bank by reason of Dojap’s failure to complete the contract;
(2) an order that the bank forthwith repay to
Dojap the sum of $J2,000,000 (being part of the deposit) together with interest
as 12% pa from October 23 1989 (being the date of rescission) down to the date
of actual payment;
(3) that the sum, if any, found due under the
inquiry as to damages be deducted from the remainder of the deposit ($J875,000)
and that the balance of the said sum of $J875,000 be paid to Dojap together
with interest as aforesaid; and
(4) an order that the bank must pay Dojap’s costs
of the appeal to the Court of Appeal.
The bank must
pay Dojap’s costs before the lordships’ board.
