Deposits in Real Estate Transactions and Pre-Incorporation Contracts

Benedetto v. 2453912 Ontario Inc. is a recent decision out of the Ontario Court of Appeal that provides a helpful summary of the rules regarding deposits in real estate transactions and applies those rules in the context of pre-incorporation contracts.

Background

The Plaintiff, Benedetto, signed an agreement of purchase and sale, which stipulated that he was buying real property “in trust for a company to be incorporated without any personal liabilities”. Benedetto provided a $100,000 deposit to secure the transaction. Later, he told the seller he would not be closing the sale and asked for the return of his deposit, which the seller refused.

Despite the “without any personal liabilities” stipulation in the agreement of purchase and sale, the motion judge found that Benedetto forfeited the deposit to the seller when the transaction did not close, reasoning that the provisions of Ontario’s Business Corporations Act, R.S.O. 1990, c. B.16 (“OBCA”) addressing pre-incorporation contracts do not displace the common law rules governing deposits in real estate transactions. The Ontario Court of Appeal agreed and dismissed Benedetto’s appeal.

The Law Regarding Deposits in Real Estate Transactions

The Ontario Court of Appeal summarized the law with respect to real estate deposits as follows (paras 5-7):

1. Where a buyer provides a deposit to secure the performance of a sale agreement, the deposit is forfeit if the buyer refuses to close the transaction, unless the parties bargained to the contrary.

2. A deposit is security for the buyer’s performance of the contract in that its potential forfeiture acts as an incentive for the buyer to complete the transaction and can compensate the seller for lost opportunity and bargaining power.

3. A deposit does not form part of the sale agreement but stands on its own, binding the contract and guaranteeing its performance.

Deposits in the Context of Pre-Incorporation Contracts

Under s. 21(1) of the OBCA, a person who enters into a contract in the name of or on behalf of a corporation before it comes into existence (hereinafter called “a promoter”) is personally bound by the contract. However, under s. 21(4), this personal liability can be expressly contracted out of. Benedetto argued that where a sale agreement stipulates that a promoter is not personally bound by the sale agreement, that promoter is not bound by a deposit given to secure the sale agreement. The appeal panel joined the motion judge in rejecting this argument, reasoning as follows (para 14):

…[A] forfeited deposit does not constitute damages for breach of contract, but stands as security for the performance of the contract. A purchaser’s obligations under a contract of purchase and sale are thus distinct from the obligation incurred by the payer of the deposit. An implied term of a deposit is that on breach of the contract by the purchaser (or, in the case of a pre-incorporation contract, by the promoter on behalf of the intended purchaser), the deposit is forfeited to the vendor.

The Ontario Court of Appeal acknowledged that parties can contract out of these rules respecting deposits but held that, in this case, it was reasonable for the motion judge to interpret “without any personal liability” as not applying to the deposit. The sale agreement had no express provision regarding the deposit and did not indicate that the deposit was to be returned to Benedetto if the contract was not performed. The Ontario Court of Appeal concluded that such a “contrary intention” would need to be “expressly stated” to prevent the deposit from being forfeited upon the buyer’s failure to perform obligations under the sale agreement. Otherwise, deposits would be meaningless, as they would provide buyers with no incentive to close and sellers with no compensation for a buyer’s failure to close (para 16).

Bottom Line

A buyer’s obligations under a sale agreement are distinct from the obligation that is incurred by the payer of a deposit. Real estate deposits guarantee performance of the sale agreement and are separate from the sale agreement itself. Thus, sellers need not prove damages or mitigate their losses in order to be entitled to the forfeiture of a deposit. Rather, deposits carry an implied term that on breach of contract by the buyer, the deposit is forfeited to the seller. This can be true even where the seller re-lists the property and is able to sell it for even more than the original sale price. Of course, parties can contract out of these rules regarding deposits, but it must be done with unambiguous language. Promoters of companies not yet incorporated must be aware that a sale agreement which includes a broadly-worded clause excluding personal liability will not extend to a deposit they provide in order to secure the sale agreement. If such a deposit is provided, the promoter’s failure to close will result in the forfeiture of the deposit unless the sale agreement clearly and specifically states otherwise.