In Tang v. Zhang, 2013 BCCA 52, the British Columbia Court of Appeal considered the interpretation of “deposit” clauses in standard form contracts for the purchase and sale of real estate. The key issue was this: where a buyer fails to complete a real estate purchase, and has paid a deposit that the contract states is to be forfeited to the seller “on account of damages”, must damages be proven in order for the seller to retain the deposit?

The Court held that a deposit will generally be forfeited without proof of damages, subject to a clear expression of contrary intention in the contract. This decision clarifies the law in British Columbia and resolves a conflict between prior inconsistent decisions.

Background

The sellers entered into a standard form contract to sell a residential property for approximately $2,000,000. The buyer paid a deposit of $100,000. The contract provided that if the buyer did not complete the sale, “the Seller [could], at the Seller’s option, terminate [the] Contract, and, in such event, the amount paid by the Buyer [would] be absolutely forfeited to the Seller … on account of damages, without prejudice to the Seller’s other remedies.”

The buyer paid the deposit, but failed to complete the transaction. The sellers subsequently went to court seeking a declaration that the deposit was absolutely forfeited to them. In the meantime, the sellers managed to sell the property to another buyer at a higher price. As a result, the seller did not suffer any damages as a result of the buyer’s failure to complete the sale.

The trial judge observed that the contract provided that the sellers “were only entitled to the deposit ‘on account of damages’” in the event that the buyer did not complete the sale. The trial judge interpreted this to mean that the sellers did not have an unconditional right to the full deposit; instead, they only had a right to claim proven damages out of the deposit funds. Because the sellers had suffered no damages, the buyer was entitled to the return of the deposit.

Decision

The sole issue on appeal was whether the deposit was absolutely forfeited without proof of damages.

The Court began by reviewing the legal principles that govern deposits. The Court observed that the common law supports the notion that, in general, a deposit is lost by the party who fails to perform a contract, even in the absence of damages, on the basis that a deposit is “not merely a part payment”, but also a practical mechanism to “creat[e] by the fear of its forfeiture a motive in the payer to perform the rest of the contract.”

The Court held that although the question of whether a deposit is forfeited is a matter of contractual interpretation, a deposit is generally forfeited without proof of damages. This is consistent with the purpose of deposits, which is to motivate contracting parties to carry through with their bargains.

However, the Court noted that the mere act of labeling a payment as a “deposit” in a contract will not permit the parties to “immunize [the payment] from judicial scrutiny.” A court is not precluded from considering whether a “deposit” is in fact a penalty (in which case relief from forfeiture is available at common law), or unconscionable (in which case relief is available in equity). The Court observed that a deposit of up to 10% of the purchase price has generally been regarded as reasonable, and noted that there was an instance in which a deposit of 20% was regarded as reasonable.

The Court expressly rejected the argument that the phrase “on account of damages” should be interpreted to limit the forfeiture of a deposit to proven damages. In the Court’s view, the phrase was intended to mean that “in any action by a vendor to recover damages against a defaulting purchaser for breach of contract, the amount of the deposit would be counted toward (or “on account of”) such damages.” Seen in this manner, “[t]he phrase forecloses double recovery if damages are proven”, which is “not inconsistent with the nature of the deposit as a ‘guarantee’ of performance which encourages contracting parties to complete their contracts in accordance with their terms.”

Tang does not preclude parties to a contract from providing that a deposit will not be forfeited unless damages are proven. However, in light of the Court’s reasoning, doing so would appear to require the use of language that clearly and unambiguously expresses the parties’ intentions to negate the general rule and the policy rationale underlying it.