Many contracts stipulate that a deposit should be paid at the outset, for example, when a commercial tenant enters into a lease with a landlord. There are many reasons why deposits are requested in commercial contracts but the main reason is to secure or guarantee the other party’s performance of the contract. Payment of a deposit creates a fear that it will be forfeited if the rest of the contract is not performed.
Often the contracts will be performed and the deposit payment will be forgotten about but what happens if the business relationship breaks down? Can the deposit payment be recovered? It is surprising that there is so little case law on the point and even more startling that the Sale of Goods Act 1979 is completely silent on the treatment of deposits.
THE COMMON LAW POSITION ON RETURN OF DEPOSITS
Under Scots common law, whether a party to a commercial contract can recover the deposit depends on what the contract says about the deposit. If the contract says that deposits are non-refundable then it is gone for good. If it says the deposit is refundable then it can be recovered.
IS A DEPOSIT CLAUSE A PENALTY CLAUSE?
The Court of Session decided fairly recently in Agri Energy v McCallion  CSOH 13 that under Scots law the rules relating to penalties do not apply to deposit clauses.
The upshot is that deposits can be unreasonable as they would not be struck down as a penalty (i.e. the amount is more than a genuine pre-estimate of loss).
Moreover the Unfair Contract Terms Act 1977 (“UCTA”) does not come to the aid of the business deposit payer either as deposit clauses are not protected by UCTA. The lack of protection for businesses is in stark contrast to consumers who have paid deposits. They are able to rely on the Unfair Terms in Consumer Contract Regulations 1999 to argue a deposit clause is unfair.
IS SILENCE ON DEPOSITS GOLDEN?
What if the contract is silent about the deposit? What then? Well it is then a matter of interpretation for the Court to decide whether parties intended the deposit to be refundable or not.
In the Scottish Inner House decision of Zemhunt (Holdings) Ltd v Control Securities plc 1992 SC 58, the judges held that “deposit” meant a pledge or guarantee of performance, not merely an advance of part of the purchase price.
THREE WAYS TO RECOVER A DEPOSIT WHERE CONTRACT IS SILENT
The Court in Zemhunt made clear that a deposit may be recovered in the following three ways:
1. If the contract is frustrated (a change of circumstances outwith the control of parties that makes performance of the contract impossible).
2. If the contract is terminated following a breach by the recipient of the deposit (in a property context, the seller or landlord).
3. If the contract is terminated by the seller following a breach by the payer of the deposit then the deposit may be recovered by a claim of unjustified enrichment (NB - the law is not terribly clear on this point as some argue if deposit payer has caused breach then shouldn't take advantage of their own wrong to recover their own deposit).
If a business wishes the deposit to be non-refundable then it would be wise to expressly state that in the contract. If the issue of the deposit is overlooked in the contract then the common law may give the payer of the deposit an avenue to recover it from the recipient in certain circumstances outlined above.
If the contract is silent on the deposit and a business wishes the deposit to be refundable then if it is has a strong bargaining position there is no reason why parties cannot agree that the deposit is refundable should the contract ultimately not be performed.
If you have any queries arising from this article, please contact our Dispute Resolution team on 0131 226 8200.
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