Three institutes most often confused in property transactions
A deposit is mentioned in almost every negotiation over the purchase of a property, and the parties usually take it to mean a right to change their mind at the cost of the sum paid. That is the most widespread misconception in property transactions. A deposit does not in itself confer a right to withdraw from the contract - on the contrary, it reinforces the contract. The right to withdraw is conferred by a withdrawal fee, while the third institute, the contractual penalty, serves an entirely different purpose.
The deposit
A deposit is a sum of money or other fungible thing handed by one party to the other on conclusion of the contract, as a sign that the contract has been concluded. Unless otherwise agreed, the contract is deemed concluded at the moment the deposit is handed over. On due performance the deposit is credited towards the obligation or returned. For a sum to count as a deposit, it must be expressly agreed as such.
What happens if the contract is not performed
Only the party that is not responsible for the non-performance may rely on the deposit, and it does so by way of choice. If the buyer who gave the deposit is responsible, the seller may demand performance where still possible, or claim damages while crediting or returning the deposit, or simply keep the deposit received.
If the seller who received the deposit is responsible, the buyer may demand performance, or claim damages together with the return of the deposit, or demand the return of double the deposit.
On partial performance the creditor may not keep the deposit, but may demand performance of the remainder together with damages for delay, or damages for incomplete performance, with the deposit credited against them. Where the contract is terminated by agreement, the rules on deposits do not apply and the deposit is returned.
How large a deposit may be
The law sets no maximum, but the party losing the deposit or obliged to return it twofold may ask the court to reduce an excessive deposit. The court considers the relationship between the deposit and the value of the subject matter, and the loss actually suffered. Case law offers a rule of thumb that a deposit should not, as a rule, exceed about 10 % of the agreed price - a guideline drawn from practice, not a statutory limit.
The withdrawal fee
A withdrawal fee is an amount promised on conclusion of the contract and paid only if a party actually withdraws. Its purpose is the opposite of that of a deposit: it gives a party a choice - to perform the contract, or to withdraw and pay the agreed sum.
The fee must be paid at the same time as the declaration of withdrawal. Once a party declares that it will pay the fee, it can no longer demand performance. Unlike the deposit, fault for the non-performance is irrelevant here.
A deposit agreed as a withdrawal fee
The two can also be combined. Where a right of withdrawal is expressly agreed alongside the deposit, the deposit is treated as a withdrawal fee and either party may withdraw: the party that gave it loses it, and the party that received it returns double. In that case even the party at fault may withdraw. This is precisely what parties usually have in mind when they agree on a “deposit” - but if the right of withdrawal is not expressly written in, that effect does not follow.
The contractual penalty
By a contractual penalty the creditor and the debtor agree on a sum the debtor is to pay if it fails to perform, performs late, or performs improperly.
One limitation is decisive for property sales: a contractual penalty cannot be agreed for monetary obligations. The buyer’s obligation to pay the price is monetary, so no penalty may be agreed for late payment - default interest applies instead. A contractual penalty is meaningful for non-monetary obligations, such as the seller’s delay in handing over possession, vacating the property, discharging encumbrances, or delivering the registration clause.
The creditor cannot claim both performance and a penalty agreed for non-performance, but may claim both where the penalty was agreed for delay. If the loss suffered exceeds the penalty, the difference may be claimed, and a disproportionately high penalty may be reduced by the court at the debtor’s request.
| Feature | Deposit | Withdrawal fee | Contractual penalty |
|---|---|---|---|
| When it is given | handed over on conclusion of the contract | promised, paid on withdrawal | promised for the event of breach |
| Confers a right to withdraw | no, unless expressly agreed as a withdrawal fee | yes, that is its purpose | no |
| Relevance of fault | only the party not responsible may rely on it | irrelevant | the debtor is not liable where the cause lies outside its responsibility |
| Monetary obligations | possible | possible | cannot be agreed |
Practical notes
- Say expressly what the payment is - a sum not called a deposit is not a deposit, and a deposit without an expressly agreed right of withdrawal confers no such right.
- If you want the option to change your mind, agree a withdrawal fee - or a deposit with an express clause that it is to be treated as one.
- Keep the deposit proportionate to the price - an excessive deposit may be reduced by the court and so loses its purpose.
- Set out the time and manner of repayment - the contract should state within what period and to which account the deposit is returned if the transfer of ownership does not take place.
The difference between these three institutes usually comes down to a single sentence in the contract, and on it depends whether the sum paid is lost, returned, or returned twofold. Our office is available to draft and review preliminary and final property sale contracts, to assess your position where the contract has already been concluded, and to represent you in a dispute over the return of a deposit or a claim for damages.