Deposit or Penalty?28th September 2012
Payment of a fixed sum by the offending party when a contract is broken is deemed to be a penalty which is unenforceable in English law. However, the one exception relates to deposits paid on exchanges of land contracts.
The general rule is that such a deposit will remain enforceable so that it can be forfeited if the contract is broken, if the deposit does not exceed 10% of the full price. A deposit exceeding the 10% figure will normally be regarded as a penalty and therefore unenforceable. In that event, the entirety of the “deposit” will be returnable to the party in breach not just the amount over the 10% figure.
However, recent case law suggests that the Courts are taking a less stringent approach to this rule. If there are special circumstances, then a deposit of more than 10% might be justifiable although it would be for the seller to establish this at trial. Those special factors could include situations where the party in breach has gone into administration (and where presumably an action for damages would bear little fruit) or where the party in breach has enjoyed a substantial benefit from the contract (such as where it has been in occupation of the property prior to the proposed completion date) or where to enforce the contract might be difficult (if one party is established in a jurisdiction where English judgments cannot be enforced) or where the contract period is a long one. This will be good news to vendors in the market where a failure to complete by purchasers is more common than was once the case.
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