Deposits and Damages in Aborted Real Estate Deals: Buyer Beware
By Peter S. Spiro
In the current state of real estate law in Canada, buyers face some serious consequences when a real estate deal fails. The buyer who does not carry through on its obligations almost always loses its deposit, and may be forced to pay additional damages to the seller. That makes it very important for the potential buyer to get good advice and think carefully before signing on the dotted line.
These consequences are a topic of increasing concern whenever real estate markets are volatile. Some buyers who were overenthusiastic and regret having bid high at the top of the market may want to get out of the deal. In other cases, a buyer may not have arranged all the financing that was needed. Even if you are a careful buyer yourself, you may get into trouble if you need to sell your present property to move up to another one. The buyer of your house may fail to carry through, leaving you with insufficient funds to close the deal on the house that you agreed to purchase.
Breaches of contract in the real estate field are not treated the same as other contracts, which is why the buyer loses the deposit. In contract law in general, there is a presumption against the enforcement of penalties. Generally, the injured party is only compensated to the extent that it can show that it has suffered damages due to the buyer failing to carry through with its purchase agreement.
The standard agreement of purchase and sale provided by the Ontario Real Estate Association does not provide a buyer with a warning that the deposit will be forfeited if he fails to close the deal. All it says about the deposit is that no interest will be earned on it.
One might think that in some situations it would be unfair for the seller to keep the deposit. Suppose that the seller can quickly resell the property at an even higher price to somebody else, leaving the seller better off due to the first deal having been broken off by the buyer. Despite that benefit, the seller still keeps the deposit.
The common law on real estate deposits received a thorough review a few years ago, in a series of cases in British Columbia that I wrote about previously.
The culminating case was Tang v Zhang. A special five judge panel of the British Columbia Court of Appeal (“BCCA”) re-affirmed the principle that a buyer who breaks the deal loses the deposit. The BCCA’s decision has subsequently been cited with approval in numerous other court decisions, including by the Ontario Court of Appeal. The BCCA held that the vendor was entitled to keep a substantial deposit, even though the evidence showed that he had been able to re-sell the property at an even higher price in a rising real estate market, and therefore suffered no damages.
The purchaser had put down a $100,000 deposit on a $2 million residential property. He was at fault for not completing the transaction, but asked to get the deposit back after the vendor re-sold the property at a higher price. He was successful at the lower court. The lower court held that the contract had to state very clearly that the deposit was non-refundable irrespective of damages, which had not been done in Mr. Zhang’s contract.
The BCCA overruled the position that the wording in the standard form contract should affect the outcome. Instead, the BCCA held that the very meaning of the word “deposit” had to be understood in terms of the historic jurisprudence on real estate deposits. For more than 100 years in Anglo-Canadian law, deposits have been non-refundable. There may be occasional exceptions, such as when the deposit is unconscionably large. There is no precise definition of that, but 25 percent has been found to be unconscionable, while 10 percent is unlikely to be.
The buyer will also lose its deposit even if it wants to complete the agreement to purchase, but has fallen into a technical violation of the agreement. This was illustrated in the recent Ontario court decision in Xu v 2412367 Ontario Limited, where Friedman Law associate Judy Hamilton acted for the vendor. This dispute was about a piece of land for development in Markham, worth over $40 million. The buyer had already paid a deposit of $1 million, and was committed to paying an additional deposit of about $2.5 million two weeks later, on September 30. The buyer ran into difficulty, because he was counting on getting money from the sale of another property, which was delayed. The September 30 deadline came and passed, and the vendor notified the buyer that it considered the deal to be cancelled. The buyer wanted to borrow money to close the deal later, but the court held that there was no obligation on the vendor to accept a late payment.
The contract in Xu v 2412367 stated, as do most real estate purchase agreements, that “time shall be of the essence.” The judge followed the leading Commonwealth case on this subject, Union Eagle Ltd v Golden Achievement Ltd, a 1997 decision of the UK’s Privy Council. In Union Eagle, the buyer was ten minutes late delivering a cheque (coincidentally, also due at 5 PM on a September 30th) because of being stuck in traffic. The court ruled that any failure to meet the deadline, no matter how small, entitled the seller to cancel the transaction and keep the deposit, which in that case was 10 percent of the price of an expensive apartment.
That principle had previously been accepted by the Ontario Court of Appeal in 1473587 Ontario Inc v Jackson. In that case, the Loblaw supermarket company had wanted to buy a piece of land for a new store, and through inadvertence was a few days late in delivering its cheque. The vendor had found a buyer who was willing to pay more, and was entitled to refuse to accept the late delivery of Loblaw’s cheque.
The seller, as the passive party in a real estate transaction, is inherently less prone to the risks of mistake in such matters.
The seller does have some responsibilities, but it is the buyer who has the more onerous task of finding the money, and ensuring it is delivered on time. That highlights the need for buyers (and their lawyers) to take extra care so that there will be no mistakes. A buyer who is relying on getting funds from the sale of another property should consider arranging bridge financing as a back-up just in case something goes wrong. The “time shall be of the essence” term is found in the standard Ontario Real Estate Association form. A buyer who has some bargaining power may be well advised to cross out that term (but that may not be practical in a hot seller’s market when there is a bidding war).
Paying Damages on Top of the Lost Deposit
As already discussed, the vendor generally keeps the deposit even if it has suffered no losses, such as when it is able to resell the property at a higher price than the original buyer offered. However, the situation becomes even worse in a falling real estate market if the vendor can prove that it has suffered damages that exceed the amount of the deposit. The vendor may sell the property at a lower price, and the buyer who failed to carry through is responsible for the seller’s loss, plus expenses.
It is possible to draft a contract to state that the deposit itself is the limit of damages, but that is not in the standard form contract. In the absence of that, the seller can sue for its actual damages. This was highlighted in another British Columbia case, Albrechtsen v Panaich, where the sale occurred after prices dropped due to the introduction of the 15 percent foreign buyer’s tax. There, the original agreement had been to purchase a house for $1,260,000, and the seller ultimately sold it for $910,000. Including expenses, the court held that the defendant was required to compensate the seller for total damages of $360,000. That would require a payment of $300,000 in addition to a $60,000 deposit that the buyer had forfeited.
A few years earlier, in Gulston v Aldred, an even larger damages award of $600,000 was made in favour of the jilted seller of a $1.6 million house.
In an Ontario case, Marsland v. Hira, 2017 ONSC 5899, the buyer was in default on an agreement to purchase a house for $1.9 million in Burlington. The vendor presented evidence that home prices have fallen substantially in that area, and he would likely suffer a loss of at least $200,000. The court granted an ex parte Mareva injunction on another property owned by the defendant to provide security for the vendor’s damage claim.
In these situations, the person selling the property does have to demonstrate that she mitigated her losses. She has to show that she took prudent measures in marketing it to get a reasonable price under the current market conditions. Otherwise, the seller can be accused of making an improvident sale and will not be compensated for all her claimed damages. However, the case law is also clear that the seller does not have to wait for market conditions to improve before selling the property. Selling into a weak market, even with the best effort, may result in a large loss.
In a somewhat different context, in Baradaran v Ontario, a debtor’s property was sold at an auction. The price realized was about $150,000 below the property’s appraised value of $1.2 million. This was found by the judge to be close enough, and so not improvident. In that case, Friedman Law associate Patrick Bakos successfully represented the party that purchased the property at the auction.
What if the Seller is the One that Breaks the Deal?
Sometimes it is the seller that has second thoughts and wants to break the deal. Empty nesters might decide to sell their house, and then have regrets because they are too attached to it. They refuse to turn over the keys when the buyer’s cheque arrives. In other cases, there may be a more mercenary motive, where the seller feels that he accepted too low a bid, and could have gotten more.
Buyers are entitled to sue a seller for damages when the seller backs out. In a hot market where real estate prices are rising, the buyer is entitled to get monetary damages from the seller. The amount of the damage is the difference between the agreed purchase price, and how much more the buyer had to pay for a similar property instead of the one on which the seller reneged.
While a buyer can in principle get compensation, it is still in a less advantageous position than a seller. The seller has, of course, paid no deposit. The buyer must go to court and prove it has suffered damages of a specified amount, unlike the seller who can keep the deposit without needing to prove that it suffered any damages at all.
Specific Performance as a Remedy when the Seller Breaches the Contract
Suppose that the recalcitrant empty-nesters refuse to carry through on the sale in a balanced real estate market where prices are stable. In that case, the disappointed buyers would not be able to show that they had suffered damages. In theory, they could buy another similar house for the same price. They will have suffered inconvenience and delay, and may suffer mental distress. In principle, it is possible to get damages for mental distress due to a breach of contract, but the damages are difficult to prove and the amounts awarded are usually modest.
Historically, disappointed buyers in such a situation would have been able to go to court and seek “specific performance.” This would be an order by the court requiring the seller to carry through with its promise and turn over the deed in exchange for the agreed payment. However, in 1996 the Supreme Court of Canada significantly curtailed this right in its decision in Semelhago v Paramadevan. That decision stands for the principle that “specific performance should not be granted as a matter of course absent evidence that the property is unique” – a somewhat subjective criterion that is not always easy to prove.
One might argue that the unavailability of specific performance ought to mean that the right of sellers to automatically keep the deposit should also be overturned. Nobody has attempted to appeal the real estate deposit issue to the Supreme Court in many decades. It is possible that the Supreme Court would recognize that the current situation is unbalanced. It could change the default rule on deposits, to be consistent with the previous change for specific performance.
However, a change in the law is unlikely to happen any time soon. For the foreseeable future, the law presents greater risks for the buyer than the seller of real estate. The lesson to take away is that buyers need to be aware that they do face these risks. They should get the right advice to ensure that the risks are controlled as effectively as possible.
The legal information in this article is of a general nature, and should not be considered legal advice to the reader.