Forfeiture of a buyer's deposit, notice to complete and Section 49 of Law of Property Act 1925

In July, the Court of Appeal decided Omar -v- El-Wakil [2001] All ER 131. Much of the Court's decision is not of general application. Nevertheless, it serves as a useful reminder of the role of the deposit in land contracts, the hazards of serving "notices to complete" (particularly prematurely) and the circumstances in which the Court is prepared to exercise its discretion under section 49(2) of the Law of Property Act 1925 and order the return of a deposit to the purchaser.

The facts of the case are rather tortuous (and have been simplified here) but centre around a dispute between Mr Omar and Mr El-Wakil over two agreements concluded on the same date. The first was a business transfer agreement whereby Mr Omar agreed to sell for £110,000.00 his car hire company, Park West Cars, and courier company, Courier Associates, to Visiontrust, a company controlled by Mr El-Wakil. Although Mr El-Wakil was not a party to the business transfer agreement, it included, amongst other things, a covenant to enter into a second agreement whereby Mr El-Wakil was to sell to Mr Omar a property in London NW11 for £350,000.00. £110,000.00 was to be paid by Mr Omar upon exchange of this second agreement with the balance of the purchase price due upon completion. Completion was scheduled to take place either on 22 April 1992 or 14 days after the date upon which Mr Omar notified Mr El-Wakil that he was ready to complete "whichever shall be the later".

The sale contract was exchanged and Mr El-Wakil served notices to complete on 22 April 1992 and again on 7 August 1992, both of which were disputed by Mr Omar and completion did not take place. Subsequently, on 20 August 1992 and 16 September 1992 Mr Omar served his own notices to complete on Mr El-Wakil and again completion did not take place. Mr Omar brought proceedings in March 1993 to recover damages for breach of contract and to recover his deposit.

Let us start with the basics.

The Deposit

A deposit is an "earnest for the performance of a contract" and, as such, is an exception to the rule under English law that a security which is not a genuine pre-estimate of potential loss is unenforceable as a penalty. If the purchaser completes, the deposit is treated as payment on account of the purchase price, but if he does not then the seller can forfeit and keep the deposit. There is no obligation to pay a deposit in the absence of express agreement, however, it is convention in property transactions to seek a 10% deposit on exchange of contracts.

Notices to Complete

Time is not automatically of the essence for completion so a sale contract will normally expressly provide that at any time on or after the date fixed for completion a party who is "ready, able and willing to complete" may give to the other a notice to complete. This makes time of the essence. If completion does not take place on the date specified, the aggrieved party is entitled to treat the contract as at an end.

The consequences of this can be summarised as follows:-

• If the buyer fails to complete, the seller may rescind the contract, keep the deposit together with accrued interest, re-sell the property and claim damages.
• If the seller fails to complete, the buyer may rescind the contract, seek repayment of his deposit together with accrued interest and claim damages.

So what damages can be claimed?

Damages will be all reasonably foreseeable losses naturally flowing from the failure to complete so as to put the "innocent" party in the position he would have been in had the purchase completed. The starting point is, therefore, the difference between the contract and market prices of the property ie, the aggrieved party's loss of profit, and other costs such as wasted legal fees or interest payable on a mortgage or bridging loan. The seller has to give credit for the deposit received. There can be no "profit" element in calculating damages. Despite the best wishes of many people buoyed by the extravagant damages awarded in the United States, punitive damages are not available.

Section 49(2) of the Law of Property Act 1925

Thus we are led neatly on to section 49(2) of the Law of Property Act 1925 which provides that "in any action for the return of a deposit, the court may, if it thinks fit, order the repayment of any deposit".

This section is designed to mitigate the seller’s right to keep the deposit where it would be "unconscionable". Experts differ in their views as to how the Court should exercise its extensive discretion. However, it is agreed that the starting point is acceptance that the buyer agreed to provide a deposit as a bond for performance and did so in full knowledge that he would forfeit his deposit if he does not fulfil his contractual obligations. The Court's discretion is, therefore, to be used sparingly.

So how did the Court deal with these issues when faced with the continual non-performance of Messrs Omar and El-Wakil?

Mr Omar -v- Mr El-Wakil

First, the Court ruled that service of a notice to complete by a party who is not "ready, able and willing" to do so is of no effect. This, in itself, is not surprising, however the Court reminded us that it is also a repudiatory breach by the party serving the notice, so that the recipient can treat the contract as at an end if the completion date passes and the party serving notice to complete fails to do so. Mr Omar did not elect to accept the various repudiatory breaches arising from Mr El-Wakil's premature notices to complete because he then proceeded to serve his own notices.

This should serve as a strong warning to anyone who seeks to serve notices to complete prematurely, for instance developers who gamble on the speed of their construction programme and serve notices based on a timetable that subsequently slips behind schedule.

Secondly, the Court reiterated that the discretion of section 49(2) of the Law of Property Act 1925 is to be exercised "where the justice of the case requires" and it should not be used simply because the sale did not complete. Mr Omar entered into the transaction knowing full well that he had to pay a deposit which would be forfeit if he defaulted. Mr Omar's conduct did not earn him any sympathy with the Court and where a buyer does not perform his obligations, the circumstances in which the Court will exercise its discretion under section 49(2) must be exceptional. Here the Court was faced with two defaulting parties. Although neither was beyond reproach, the Court refused to exercise its discretion in Mr Omar's favour.

Fault is not the only factor that the Court considers. One important example of the Court being willing to exercise its discretion is where the seller goes on to make a significant profit in the resale of the property. This is possibly a judicial aversion to the proverb "every cloud has a silver lining", but it removes the windfall element for a seller who goes on to do a better deal. In such circumstances, the Court has ordered the return of the deposit to the buyer.

Remember.....

The lessons to be learned can be summarised quite succinctly:-

1. You must be "ready, able and willing to complete" on the date specified in your notice to complete. If not, the other party may treat your failure to complete as a repudiatory breach, entitling him to walk away from the transaction. Do not serve notice in the hope that you may be ready -the risk may be too high.

2. Generally speaking, the innocent party gets to keep the deposit - but not always. Remember the Court's broad discretion under section 49 of the Law of Property Act 1925 to order the return of the deposit - even to a defaulting buyer - if the justice of the case requires it. The bottom line is that no windfalls are guaranteed in a buoyant property market!

For further information please contact Caroline DeLaney on +44 (0)20 73672329 or at caroline.delaney@cms-cmck.com This article was first published in Property Week, 8th August 2001