A deposit paid on exchange of contracts performs two different functions. It acts as a payment on account and will be applied towards payment of the purchase price. However, it also serves as a guarantee of performance because the seller will have the right to forfeit the deposit if the buyer defaults.
What is the legal position if a buyer pays a pre-contract deposit as a sign of good faith but subsequently withdraws without entering into a contract with the seller, or discovers that an agreement is void because it fails to meet the statutory requirements laid down in section 2 of the Law of Property (Miscellaneous Provisions) Act 1989? Can a buyer ask for its money back on the ground that the seller has no contractual right to it?
A deposit paid on exchange of contracts performs two different functions. It acts as a payment on account and will be applied towards payment of the purchase price. However, it also serves as a guarantee of performance because the seller will have the right to forfeit the deposit if the buyer defaults.
What is the legal position if a buyer pays a pre-contract deposit as a sign of good faith but subsequently withdraws without entering into a contract with the seller, or discovers that an agreement is void because it fails to meet the statutory requirements laid down in section 2 of the Law of Property (Miscellaneous Provisions) Act 1989? Can a buyer ask for its money back on the ground that the seller has no contractual right to it?
In its report, Transfer of Land (1987), which preceded the enactment of section 2, the Law Commission explained that contracts that failed to satisfy the statutory requirements would be void. In such circumstances, buyers would generally be entitled to recover their deposits because they would not have received anything in return for their money.
Sharma v Simposh Ltd [2011] EWCA Civ 1383; [2011] PLSCS 276 concerned a substantial deposit paid under an agreement giving the buyers an option to purchase property then under construction. The agreement was void because it was oral. As a result, the buyers were able to withdraw when the economy faltered – but they also asked for their money back. The trial judge acknowledged that the parties had agreed that the payment was non-refundable. However, he ruled that the buyers were entitled to recover their deposit.
The Court of Appeal disagreed. It accepted that, in many cases where a deposit is paid under a contract to buy land that is void under section 2, the buyer will be entitled to recover its money because the payment was made in respect of an expectation that has not been met. However, each case will turn on its own particular facts.
The key question was whether the deposit was paid conditionally or not. If the payment was conditional, or was made “subject to contract”, the developer would have had to return it when the transaction fell through. However, this was not the case here. The property in the deposit was intended to pass to the developer immediately, to provide a sanction against withdrawal.
The court accepted that this did not exclude the possibility of a claim for the return of the deposit under the law of restitution, but ruled that the developer would not be unjustly enriched by the retention of the deposit. The parties had entered into a commercial transaction. They were each able to look after themselves and there was no inequality of bargaining power between them. The developer had kept his side of the bargain. The buyers had got what they paid for and there had not been any failure of consideration in this case.
It will be interesting to see whether sellers try to take advantage of this decision. If so, we may see further litigation on this subject.
Allyson Colby is a property law consultant
