Consider:
Amy owns a commercial property in the GTA that she decides to sell. She enters into an Agreement of Purchase and Sale (“APS”) to sell her property to Bob for $10m. Bob paid a $500,000 deposit. The completion date stated in the APS is May 1st, 2025.
May 1st arrives, and Bob fails to tender the purchase price above the 500k deposit.
Amy terminates the agreement. She re-lists and sells the property to mitigate (reduce) her loss.
Scenario A – The market is rising, and Amy happily re-sells the property to Cathy for $10.5m. Good for Amy 🙂 ; or
Scenario B – The market is falling. Amy is sad. The highest amount she can sell the property for is 8 million dollars.
What happens to Bob’s deposit?
Forfeiture of deposits
As a general rule in real estate transactions, if the purchaser fails to complete the transaction as obliged under the Agreement of Purchase and Sale, the deposit is forfeited to the seller, regardless of whether the property goes up or down in value after the purchaser’s failure to close and the vendors’ re-sale of the property. Even if the vendor has not suffered a loss. Why?
In essence it is because deposits have been seen by the courts as serving a unique function. In the context of real estate transactions, the principle permitting forfeiture is underpinned by the belief that:
(a) the seller has lost an opportunity to sell the property to another potential buyer after entering into an Agreement of Purchase and Sale;
(b) the seller’s bargaining power with everyone other than the defaulting purchaser has been lost by the seller having revealed to the market the price at which the seller was willing to sell to the defaulting purchaser1See Benedetto v. 2453912 Ontario Inc., 2019 ONCA 149 (CanLII), para 6.; and
(c) a deposit is a deterrent to a breach. A deposit is regarded by the court as “…not merely a part payment, but … also an earnest to bind the bargain so entered into, and creates by the fear of its forfeiture a motive in the payer to perform the rest of the contract”. 2Benedetto v. 2453912 Ontario Inc., 2019 ONCA 149 (CanLII), para 5.
Penalties & Relief from forfeiture
But – like in many instances under the law – there are exceptions to the general rule.
While the principles of forfeiture of deposit are driven by the idea of contractual freedom, and holding people to their bargain, the principle against unconscionability serves as a gatekeeper against grossly unfair results.
Returning to the above scenario, imagine this: Bob paid Amy a 50% deposit ($5m) instead of 5%, and Amy made another $2m profit from the resale after Bob failed to close on the transaction as contractually required. Does our friend Amy still have the legal right to keep the entire $5m deposit paid by Bob? If so, wouldn’t that feel like, as Bob might probably put it, “a rip-off approved by the court?” 3One argument in Amy’s favor is that the court has no part to play in attempts to rewrite a contract freely entered into by sophisticated parties. However, gross unfairness may call for court intervention.
Here, the court may refuse to enforce the $5m forfeiture on two overlapping grounds. First, the court may strike down the contractual clause as a penalty as being oppressive and unconscionable.4The power to strike down a penalty clause is rooted in the court’s equitable jurisdiction to provide relief against oppression and unconscionability. Second, under s 98 of the Ontario Court of Justice Act, the court has the power to grant relief against forfeiture where forfeiture would be unconscionable.5The threshold for unconscionability is generally high. The fact that Amy suffered no loss from the re-sale does not, in itself, mean unconscionability.
These two grounds are often discussed together in case law. A difference, however, appears to be that for penalty, the primary consideration is whether the specified amount was extravagant at the time the contract was entered into,6See H.F. Clarke Limited v. Thermidaire Corp. Ltd., 1974 CanLII 30 (SCC), [1976] 1 SCR 319. whereas for relief against forfeiture, the court tends to balance a wider range of factors. These include post-contractual circumstances such as the conduct of the parties.7See Redstone Enterprises Ltd. v. Simple Technology Inc., 2017 ONCA 282 (CanLII), para 30.
Some of the factors the court will consider in determining unconscionability are as follows:8See Redstone Enterprises Ltd. v. Simple Technology Inc., 2017 ONCA 282 (CanLII), para 30.
– inequality of bargaining power;
– a substantially unfair bargain;
– the relative sophistication of the parties;
– the existence of bona fide negotiations;
– the nature of the relationship between the parties;
– the gravity of the breach and the conduct of the parties.
With these concepts explained, it is important to bear in mind the devil is in the details – the nuances of the contractual language, the two sides to the story, and the strength of the evidence. If you happen to be Amy or Bob, or anyone running into a property or commercial dispute, reach out to our litigation team. We help you think through your options and strategies as guided by legal principles, business sense, and practical considerations.
Disclaimer: This newsletter is for informational purposes only and should not be used as a substitute for competent legal advice from a licensed professional in your region.
Chit Leung
Dan Chitiz