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Deposits, stage payments and penalties

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Summary: The established treatment of deposits under land contracts has been brought into question in the recent case of Amble Assets [2011] EWHC 1943 (ch) (“Amble Assets”), where a series of deposits totalling some 60% of the full price had been paid.

It has been established practice that a deposit payable on exchange of a land contract in England and Wales should not exceed 10% of the full price payable on completion.

The legal position underpinning this practice is that a deposit of this size is “earnest money”; a pledge by the buyer of completion of the transaction.  If the pledge is broken, then the seller is entitled to retain the deposit, without proving his loss from the broken contract and irrespective of whether he has suffered loss.

The court does have specific jurisdiction to order the seller to repay a deposit so held as “earnest money” and a seller and a buyer cannot validly exclude this jurisdiction from their contract.  However, orders for repayment by the court are made only in highly exceptional circumstances.

This practice has operated as an exception to the general practice governing fixed sums payable should a contract be broken.  These take two forms; either the sum is a legitimate pre-estimate of loss or is an unenforceable penalty.

In Amble Assets, the essential facts were that a price of £1.9m was agreed for a food processing plant and its equipment and the buyer allowed into possession on exchange and on payment of a “non-returnable” deposit of £800,000.  Following failure to complete on the agreed completion date and the instigation of legal proceedings, revised terms were negotiated, with an increase in the price to reflect interest and expenses and a further “non-returnable” deposit of £500,000 paid.  Again, the buyer failed to complete and went into administration which led to the sellers also being placed in administration.

Administrators acting for the sellers sought to retain the two deposits; those acting for the buyer argued for their repayment.  The buyer relied on the established practice that the deposits being in excess of 10% could not amount to “earnest money” and so should be struck down as penalties and repaid in full.  The court declined to apply the established practice and automatically strike down the deposits as penalties.

The court ruled that it was possible for a payment in excess of 10% of the purchase price to constitute “earnest money” in special circumstances, although it would be for the sellers to establish this at a full trial.  That is still to be heard, but the preliminary ruling is significant in challenging the established practice.

Nevertheless, where the seller wishes to demand a payment on exchange exceeding 10% of the full price but still treat the payment as a deposit (with the benefit then attached to treatment as earnest money) the seller will need to demonstrate special factors attaching to the deal.

Special factors could arise:

• in an insolvency situation (in Amble Assets the sellers were in extreme financial difficulties with a competing bid on  alternative terms disclosed to the buyer);

• where the contract breaker has enjoyed a substantial benefit from the terms of the contract in advance of completion (in  Amble Assets, the buyer was let into possession to operate the plant, its machinery and carry on its own business);

• where enforceability of the contract against the buyer might be difficult (for example, if the foreign domicile of the  buyer is one with which the English courts do not have an enforcement of judgement agreement) so justifying a higher  figure as appropriate “earnest money”; and

• where the contract period is a long one to guarantee continued commitment by the buyer (and sales “off plan” in certain  circumstances may qualify here).

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