January 26 2001
Case law has established that a seller who insists on receiving a deposit exceeding 10% of the price of the property in question runs the risk of not being entitled to keep the deposit if the buyer defaults, unless there are special circumstances. The case of Polyset Limited v Panhandat Limited (Court of Appeal CACV70/2000 October 20 2000) provides an example of such special circumstances.
An agreement was signed in May 1997 for the sale of a property for HK$115 million. Completion was to take place in March 1998 but this was later deferred until April 1998. Deposits totalling HK$40.25 million (ie, 35% of the price) were paid by the buyer.
Between the agreement and completion dates, the value of the property fell considerably. In March 1998 the buyer purported to rescind the agreement on the ground that the Building Authority had complained about unauthorized work at the property. However, the seller subsequently complied with the Building Authority's requirements and the buyer's refusal to complete was held to be unjustified.
One of the grounds of the buyer's appeal was that the deposit of HK$40.25 million was a penalty and that it should only be liable for HK$33 million, which was the amount of damage suffered by the seller.
The Court of Appeal referred to the general rule that a seller who seeks to forfeit a deposit larger than the customary amount must show special circumstances to justify such a deposit. The court found that there were special circumstances in this case and so the seller was entitled to keep the whole deposit.
The special circumstances arose from the highly volatile nature of the Hong Kong property market at that time. The value of the property had risen considerably just before the sale. The seller had good reason to believe that this rise might not be sustainable and that the value of the property might drop to its previous level, particularly as there was more than nine months to completion. Therefore, the 35% deposit could be considered a genuine estimate of the seller's likely loss if the buyer did not complete.
The court was also influenced by the fact that the parties had entered the contract on an equal footing with a view to making a profit out of the transaction. The contract was at arm's length and both parties were, or had the facility to be, properly advised.
This case will be helpful to sellers at times when the property market in Hong Kong is volatile. When a property is worth much less than the sale price at the completion date, many buyers will choose to default and lose the deposit rather than incur further losses by completing. Some buyers will be unable to complete because they cannot obtain the necessary finance due to the fall in value of the property.
Even if a seller is entitled to sue a defaulting buyer for the loss it suffers through the buyer's failure to complete, actually obtaining damages from the buyer may be time consuming and possibly unsuccessful. Therefore, the ability to charge and subsequently forfeit a large deposit will be an attractive option for sellers.
For further information on this topic please contact Sally Durant at Baker & McKenzie by telephone (+852 2846 1888) or by fax (+852 2845 0476) or by e-mail (Sally.Durant@BakerNet.com).
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