Forfeiture of Deposit – Read the Contract

Alan E. Farber, Farber & Company
June 2005

The rapid escalation of prices in the real estate market have given Purchasers a false sense of security if they enter into an agreement of purchase and sale and change their mind and fail or refuse to complete the transaction. There is an ongoing obligation for the Vendor to mitigate their losses by reselling the property as soon as possible. In today’s market this almost always means the Vendor will resell at a profit thereby relieving the Purchaser of the necessity to pay damages to the Vendor for loss of profit. Many Purchasers, however, forget that they may still be responsible for the deposit which was placed in trust at the time of entering into the agreement. Almost all agreements contain a forfeiture clause giving the Vendor the right to forfeit the deposit. In high-end units the deposit can total as much as 25% of the purchase price. A Purchaser who enters into such an agreement with the advice of an agent or a lawyer should look at the forfeiture of deposit clause carefully and understand its meaning. The clause usually contains a statement that in the event that the contract is not completed by the Purchaser of the date set for closing “the deposit will be forfeited to the Vendor as a genuine pre-estimate of liquated damages”. This clause has been interpreted by the courts as binding on a Purchaser who willingly enters into a contract and it is rare case where the Purchaser will be able to recoup their deposit from the Vendor who forfeits it.

The clause, a genuine pre-estimate of liquidated damages, is put in the contract to distinguish it from a penalty which, in law, is not forfeitable. The courts have enforced that clause and said in a volatile real estate market which may go up or may go down the parties have a right to attempt to quantify their potential losses and enter into an agreement setting that out.

The Purchaser who wishes to obtain his deposit back may commence action in court and state that although the clause says it is a genuine pre-estimate of damages it really is a penalty because it is excessive and unconscionable. The Law and Equity Act of British Columbia has a section which allows relief from forfeiture but that relief will only be granted by the courts when the conscience of the court is moved and the court finds that the deposit is excessive or extravagant. The court may also conclude that the Vendor conduct has constituted a fundamental breach of contract and allowed the deposit to be returned on that basis.

In a recent case in British Columbia the Purchaser bought a high-end condominium unit in a building yet to be built in downtown Vancouver, the purchase price was $2,000,000.00. The deposit of 20% or $400,000.00 was written into the contract as a genuine pre-estimate of liquidated damages to be forfeited in the event of non-completion. Two years later when the building was complete the Purchaser was unhappy about the various items and refused to close the transaction. The Vendor seized the opportunity and resold the unit at a price $1,000,000.00 higher than the initial purchase price. In addition, the Vendor forfeited the Purchaser’s deposit. The Purchaser commenced action for return of the deposit on the basis that it was extravagant and unconscionable. The court said that the defendant Developer did not breach the fundamental terms of the contract and that the Purchaser was not entitled to relief from forfeiture as the deposit was not extravagant, excessive, or unconscionable in a volatile real estate market. In addition, the parties entered into the agreement with full advice of their professionals, each being represented by a real estate agent. As such the court found that the clause, a genuine pre-estimate of liquidated damages, was valid and binding on the Purchaser and the deposit was forfeited. The court found that although the Vendor made a profit of over a million dollars in addition to the forfeiture of the deposit the Purchaser could have closed the transaction and made the same profit himself, he chose not to do so.

When entering into an agreement of purchase and sale read the forfeiture clause carefully and understand the dangers to a Purchaser of the forfeiture of deposit clause.

Farber & Company
#200 – 1067 Richards Street
Vancouver, BC V6B 3E5