When is it acceptable to have a 20% deposit in a Sale of Land contract? The NSWCA provides clarification on both the 'penalty doctrine' and s 55(2A) of the Conveyancing Act

The NSW Court of Appeal decision of Sydney Developments Pty Ltd v Perry Properties Pty Ltd (2016) NSW ConvR 56-364 provides a very useful contemporaneous address to both:

1. the penalty doctrine as it relates to deposits for the sale of land; and

2. s 55(2A) of the Conveyancing Act which allows for a court ordered return of deposit to the purchaser, if the court thinks fit, after the contract is terminated.

The penalty doctrine is, at its most basic, a doctrine whereby the court strikes out (i.e. rules unenforceable) a clause in a contract involving the payment of a set amount of money, if that clause is deemed to be penal in nature.

With respect to liquidated damages clauses (clauses setting out a specific sum payable in the event of a breach of contract) in order for the clause to be enforceable (and not a 'penalty') it must be said to be "a reasonable pre-estimate of the loss likely to be suffered by virtue of the breach of contract".

But the penalty doctrine is slightly different in its application when it comes to deposits. A deposit clause merely needs to be said to be an "earnest of performance" in order for the clause to be enforceable [see the distinction set out by Barwick CJ in NLS Pty Ltd v Hughes (1966) 120 CLR 583 at 589].

In practice, a 10% deposit is common place in a standard sale of land contract. On the other hand, there have been cases where the courts have struck out deposit by instalment clauses involving 5% deposits (many decided on the issue of drafting – see for example Ianello & Anor v Sharpe [2007] NSWCA 61).

A deposit higher than 10% runs a risk of being deemed penal. But as the NSWCA has recently confirmed, a deposit of 20% can be enforceable in matters involving a delayed settlement, commercial minds, and an absence of anything unjust.

• Sydney Developments Pty Ltd v Perry Properties Pty Ltd (2016) NSW ConvR 56-364

On 2 September 2015, the SD entered into a contract with Perry Properties to purchase a property in Ashfield for $4.7million. The Completion Date of the Contract was 274 days from date of contract.

Reflecting an increasingly common practice for lengthy settlement periods, the vendor (Perry Properties) insisted and the purchaser agreed on special condition (SC 25) which set out that an additional 10% of the purchase price was payable as a deposit 122 days from date of contract, in addition to the 10% deposit paid at the date of exchange of contracts.

In other words, the purchaser was required to pay:

* 10% on 2 September 2015 as the first instalment of the deposit.

* a further 10% on 2 January 2016 as the second instalment of the deposit.

* 80% balance of purchase price on 2 June 2016.

When it came time to pay the second 10%, the purchaser could not come up with the funds on time. With time being of the essence for payment of deposits, the vendor determined it was entitled to terminate the contract and issued a notice of termination on 6 January 2016. The purchaser in turn argued that Special Condition 25 was a penalty, was thus unenforceable, and that the vendors had themselves repudiated the contract by seeking to terminate the contract on the basis of an unenforceable clause. The purchaser in reply asserted that it accepted the vendor's repudiation of contract, and themselves issued a termination notice on 16 February 2016.

The purchaser filed a Summons in the Supreme Court seeking the return of the initial 10% deposit.

The court had to consider:

1. was the 20% deposit clause enforceable or should it be classified as a penalty and struck out from the contract?; or alternatively

2. even if valid, should the deposit be returned to the vendor nonetheless by virtue of an order pursuant to s 55(2A)?

His Honour Darke J held:

* the clause was enforceable,

* the order sought under s 55(2A) should be rejected,

* the vendors had validly terminated the contract after the purchaser failed to pay the second 10% deposit instalment, and

* the vendors were entitled to retain the first 10% instalment.

In relation to question [1], while a deposit "in earnest" is usually 10% when it comes to Sale of Land Contracts (see Luu v Sovereign Developments Pty Limited [2006] NSWCA 40 at [24] – [25]), in the circumstances of this case with the lengthy settlement period, the 20% deposit was said to be one payable in earnest of performance.

This case was distinguished from Workers Trust and Merchant Bank Limited v Dojap Investments Limited [1993] AC 573, where a 25% deposit payable in full by 14 days from the date of auction failed to meet the 'earnest money' test and was accordingly struck out.

The second deposit was also said not to be a clause disguised as collateral to primary obligation (in other words, a clause to threaten the other party to ultimately perform).

The submission that the clause was also an instalment of price, and not a deposit, was also rejected.

In relation to question [2], the court held there is a discretion under the statute to order the return of the deposit nonetheless, but the discretion in considering the justice and equity of the case "must appreciate the legal context of the established nature of a deposit as an earnest of performance in conveyancing transactions" - para [55].

Darke J held that that it would not be unjust or inequitable for the vendor to keep the first 10%.

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