Frequently disputes occur regarding deposits and whether they are refundable if a purchase does not complete for whatever reason.
In law there is no requirement for a buyer to pay or a seller to demand a deposit. There must be a specific provision in the contract. The starting point is therefore to examine the contract. What did the parties actually agree that this payment would represent?
There are two classes into which the payment might fall. It is either:
- A deposit; or
- A part-payment in advance.
The distinction is particularly important when considering whether it is refundable or not if the contract is not completed for whatever reason.
What is a deposit and how does it differ from part-payment?
Deposit
“a guarantee that the purchaser means business”
In the authority of Howe v Smith (1884) 27 Ch D 89, a deposit is characterised as:
- security for the performance of the contract; and
- part payment of the purchase price.
To be a deposit it is important that both elements are present. A mere part-payment of the purchase price is not a guarantee of the seller’s performance and is therefore treated differently from a deposit.
If a payment constitutes a deposit, then the general rule is that the deposit is non-refundable upon breach of contract. As such, if the buyer fails to perform the contract or pulls out of the purchase, the buyer has no right to the return of the deposit if the seller terminates for the buyer’s repudiatory conduct. This is because the deposit payment was made as security for performance.
Part-Payment
In comparison, a part-payment it not a guarantee of performance. This means that if the buyer fails to perform the contract or pulls out, the buyer can claim a refund of any advance payments. That said, the buyer would be liable to the seller in damages for the breach. A seller’s right to retain any part-payment is therefore not automatic and they would need to prove its losses.
In broad summary, a deposit is a guarantee of the buyer’s performance of the contract, whereas a part-payment is exactly that: a part-payment of the price.
Is a payment a deposit or part-payment?
Whether an advance payment is a deposit, or a mere part-payment depends on what the parties intended when entering into the contact.
If a contract expressly describes the advance payment as a ‘deposit’ and is silent about whether it is refundable or not, then it will generally be classed as a deposit. The payment will therefore not be refundable.
Alternatively, if the contract does not describe the advance payment as a deposit and there are no grounds to believe that the payment is unconditional on the buyer’s performance, it will be classed as a part-payment. The payment will therefore be refundable, subject to any losses the seller may be able to claim if the buyer has cancelled in breach of the contract.
In the absence of a written contract, what was said and done then has to be examined to find out whether the parties intended that the payment would be a deposit or not.
Size of deposit
The amount of deposit is a matter for negotiation between the parties. That said, the size of the deposit must be reasonable taking into account all of the circumstances of the transaction as a whole.
If the deposit is significantly high compared to the total purchase price, then it could be held as a penalty. As a matter of public policy, penalty clauses in contracts are unenforceable. Each matter depends on the particular facts and parties are therefore advised to obtain legal advice if there is a dispute regarding a deposit payment.
Conclusion
In summary, a deposit is security for the buyer’s performance of the contract. It is generally not refundable unless the contract expressly states otherwise. In contrast, a part-payment is refundable, subject to any losses that the innocent party may have as a result of the breach.
Each contract needs to be considered on a case by case basis. If you are an individual or business and would like further advice on this subject, please contact the Dispute Resolution team at drteam@herrington-carmichael.com or call us on 01276 686222.
This reflects the law at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought as appropriate in relation to a particular matter.
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