The forfeiture of a deposit is one of the major tools for ensuring that contracts are performed. But there is a debate about whether a deposit can be forfeited if the party forfeiting it has suffered no damages, or damages less than the amount of the deposit. Until recently in British Columbia, there were decisions of the Court of Appeal going both ways:
-one holding that a deposit can be forfeited if the forfeiting party has suffered no damages;
-the other holding that a deposit can only be forfeited to the extent that damages are suffered by the forfeiting party.
The British Columbia Court of Appeal has recently resolved this debate. In Tang v. Zhang, that court adopted the first approach: the deposit can be forfeited even if the forfeiting party has suffered no damages. However, the court still retains discretion to reduce or disallow the amount of the forfeiture if the amount of the deposit is unreasonable or its forfeiture would be unconscionable.
The facts in the Tang case involved an agreement of purchase and sale in the standard form contract used by the Greater Vancouver Real Estate Board. The sale price was $2,030,000 and the buyer paid a deposit of $100,000. The agreement said in effect that if the buyer did not complete the agreement, then “the amount paid by the Buyer will be absolutely forfeited to the Seller….on account of damages, without prejudice to the Seller’s other remedies.”
The buyer failed to close the transaction and the seller forfeited the deposit. The buyer sued to recover the deposit and argued that the proper interpretation of the agreement was that the deposit could only be forfeited to the extent that the seller had suffered damages.
The British Columbia Court of Appeal traced the law relating to deposits back into English law. It referred to the decision of the English Court of Appeal in Howe v. Smith (1884) 27 Ch. D. 89 as being the “seminal authority on the nature of a deposit.” That decision held that a deposit is “security for the completion of the purchase” and “creates by the fear of its forfeiture a motive in the payer to perform the rest of the contract.” While the contract in that case said that the monies were paid “as a deposit and in part payment of the purchase money”, the court said that “the reference in the contract to part payment would have come into operation had the buyer completed the purchase. That ‘alternative’, however, did not overcome the nature of the ‘deposit’ as security for performance that was forfeited when the buyer repudiated his bargain.” The English Court of Appeal allowed the deposit to be forfeited even though the defendant had sold the property at the same price and had suffered no damages.
The British Columbia Court of Appeal traced the rule in Howe v. Smith into Canadian law and its adoption by the Supreme Court of Canada. That rule, the B.C. Court of Appeal explained, is an exception to the rule against penalties. A deposit, it said, is “non-refundable” by definition. It is not necessary to use the word “absolutely” or other modifier to qualify “non-refundable” as the non-refundable nature of a deposit is “simply a matter of definition” subject to a contrary intention being shown.
Accordingly, the words “on account of damages” in the agreement in Tang-Zhang agreement referred to the fact that the monies would be applied on account of the purchase price if the purchaser completed the contract but did not mean that the deposit could not be forfeited if the seller suffered no damages.
The Court held that, while the rule relating to deposits was an exception to the common law rule against penalties, it was not an exception to the rule of equity prohibiting unconscionable forfeitures. Accordingly, if the deposit was excessive, the court could grant relief. The buyer had not argued that the deposit was penal or unconscionable. The court referred to a variety of cases and other sources in which a 10-20 percent deposit had been held to be reasonable. In those circumstances, the court upheld the deposit and over-ruled its prior decision to the contrary. The court set forth five helpful rules to apply to the interpretation of agreements referring to deposits.
Deposits are not just found in real estate transactions. A wide range of commercial agreements use deposits to secure performance of the contract, and construction law often uses them for tenders. So this decision is of general commercial interest.
The Tang v. Zhang decision is significant for a number of reasons:
First, the five principles stated at the end of the decision are a useful touchstone to pull out any time a refresher on the law of deposits is needed.
Second, the decision reminds us that, if the word “deposit” is used, then other adjectives will not destroy the forfeiture unless they demonstrate that forfeiture was not intended, and using words such as “on account of damages” or “in part payment of the purchase price” will not remove the forfeiting nature of a deposit.
Finally, if the amount of the forfeiture is egregious, the court still retains the equitable jurisdiction to relieve against the forfeiture.
See Heintzman and Goldsmith on Canadian Building Contracts, (4th ed.), Chapter 6, part 2(b)(i)(B).
Tang v. Zhang, 2013 BCCA 52
Building Contract – Deposits - Liquidated Damages and Penalties - Relief against Forfeiture
Thomas G. Heintzman O.C., Q.C., FCIArb October 4, 2013