Deposits are a common feature of real estate transactions, standing as “security for the purchaser’s performance of the contract” (see Benedetto v. 2453912 Ontario Inc.). But are there circumstances under which a buyer will be entitled to the return of a deposit for a failed purchase? The legal principles surrounding this issue are relatively complicated and were recently discussed by the Superior Court of Justice in Gagliardi v. Al-Karawi.
Within 24 Hours Of Accepting A Counteroffer, Buyer Retracts Offer
In Gagliardi, the defendant buyer agreed to purchase property from the plaintiff’s vendors for $635,000. Acceptance of the defendant’s counteroffer was communicated to the defendant’s real estate agent on April 3, 2022. At 7:38 a.m. the next day, that real estate agent emailed the real estate agent for the vendors to say the defendant “would not be proceeding with the deal for personal reasons.” Given the short time between acceptance of the counteroffer and this email, the MLS listing status for the property never changed, and a week later, the property sold for $622,527.
The agreement of purchase and sale in issue was on a “standard Ontario Real Estate Association form.” A term of the form stipulated that the buyer would submit a deposit “upon acceptance” in the amount of $40,000. The term “upon acceptance” is further defined as the buyer’s requirement to deliver the deposit “within 24 hours of the acceptance” of the Agreement. The buyer never paid the $40,000 deposit to the vendors.
The plaintiffs brought a claim seeking judgment for the amount of the unpaid deposit, as well as damages equal to the difference between the purchase price agreed to by the defendant and the price for which the property ultimately sold. They also sought punitive damages. The matter came before the Court for determination by way of summary judgment.
Seller is Generally Entitled to Retain a Real Estate Deposit Where a Deal Falls Through Because of a Buyer’s Default
In its decision, the Court began by noting the legal principle that holds a vendor is generally entitled to retain a deposit paid for a property purchase that is not completed because of a default by the buyer. While several rationales have been put forward justifying this principle, Canadian courts have, by and large, emphasized it is because a deposit secures a buyer’s performance of the agreement and incentivizes the completion of the purchase.
The Law Requiring Forfeiture of a Deposit is an Exception to the General Rule Against Enforcement of Penalty Clauses
Generally speaking, a term in a contract requiring a breaching party to “pay or forfeit a sum of money to the other party” is considered unlawful and unenforceable. However, if the contractual term requiring payment “can be justified as being a payment of liquidated damages,” it will be an exception to this rule. Such a term is often called a “liquidated damages clause.” A clause will fall within this exception if it provides for the payment of an amount that constitutes “a genuine pre-estimate of the loss which the innocent party will incur by reason of the breach.” Likewise, the principle requiring the forfeiture of a deposit is generally not subject to the rule against enforcement of penalty clauses.
Seller’s Damages Are Generally Reduced by the Amount of the Retained Deposit
Where an amount constitutes a deposit, and the vendor suffers damages due to the buyer’s breach, the amount of damages to which the vendor is entitled generally will be reduced by the amount of the deposit. Further, where the deposit is greater than the amount of damages suffered, the damages will usually not be recoverable in addition to the deposit. Similarly, the buyer will still forfeit the deposit if the vendor suffers no damages. Of course, parties are free to agree otherwise in their contract.
In applying these principles to the facts of the matter, the Court concluded that the law favoured requiring the defendant to pay the plaintiffs the $40,000 owed as a deposit. This also meant the plaintiffs could not claim for damages. However, the Court noted that this requirement was subject to any relief from forfeiture available to the defendant.
Court Reviews Law of Relief From Forfeiture
What is meant by relief from forfeiture? Section 98 of the Ontario Courts of Justice Act grants courts the power to “grant relief against penalties and forfeitures, on such terms as compensation or otherwise as are considered just.”
The Court noted that, in Ontario, relief from forfeiture was available in deposit cases, although granting such relief was “exceedingly rare.” The Court went on to note that two legal tests for relief from forfeiture had evolved in the common law and was faced with selecting which test to apply.
The two tests in question had been outlined in the earlier Supreme Court of Canada case of Saskatchewan River Bungalows Ltd. v. Maritime Life Assurance Co. and the U.K. case of Stockloser v. Johnson. The former case is “the leading authority in Canada on relief from forfeiture.” However, as the Court noted, Canadian courts have tended to apply the test set out in the Stockloser case in deposit cases.
Under Saskatchewan River Bungalows, various criteria are to be considered in determining whether or not to grant relief from forfeiture, namely (a) the conduct of the party seeking relief, (b) the gravity of the breach of contract, (c) whether the right of forfeiture was intended to secure the payment of money and (d) whether there was a “substantial disparity between the value of the property forfeited and the damage caused” by the breach (per Gagliardi).
Conversely, under Stockloser, “two things are necessary for the equity to relieve the buyer from forfeiture: (1) the sum forfeited must be out of all proportion to the damage, and (2) it must be unconscionable for the seller to retain the money” (per Gagliardi).
The Court applied the various criteria referenced in Saskatchewan River Bungalows and found most of the criteria did not weigh against the request for relief from forfeiture. It observed that the defendant’s conduct had not been willful, that for the most part, the breach had “caused no meaningful consequences to the plaintiffs,” that the purpose of the deposit had been to secure the payment of money, and that a significant discrepancy had existed between the amount of the deposit ($40,000) and the amount of damage suffered by the plaintiffs ($12,473).
What Is Unconscionability In The Context Of Deposit Cases?
The Court also considered whether it would be “unconscionable” for the defendant to retain the deposit. Specifically, the Court asked whether a “disproportionately large deposit” could be unconscionable. It noted that, while possible, it would be difficult to prove such unconscionability in a deposit case because real estate deals “rarely involve vulnerable parties or significant unequal bargaining power.” In applying this criterion to the case, the Court concluded that the plaintiffs could “in no way be accused of oppression, extraction of an extravagant sum, or sharp exercise of contractual rights.” Accordingly, “under the Stockloser formulation,” this factor weighed against relief from forfeiture.
Court Determines that the Stockloser Test Should Apply
Faced with two different results depending on which legal test it applied, the Court ultimately concluded it was appropriate to adopt the Stockloser test. It did this primarily because deposit cases should be treated differently and as an exception to the relief from forfeiture principles set out in Saskatchewan River Bungalows. As the Court noted, “unconscionability should be measured by reference to precedent,” and the “vast weight of authority” favoured denying relief from forfeiture. Accordingly, the request for such relief was denied.
For Legal Advice Regarding Commercial Real Estate Litigation and Contract Disputes Contact Milosevic & Associates
The lawyers at Milosevic & Associates in Toronto are available to provide strategic and practical litigation advice in commercial real estate disputes. Our legal team is available to provide efficient and effective representation. Contact us online or by phone at (416) 916-1387 for a consultation.