Anonymised, illustrative composite. The buyer waived its financing condition, the lender withdrew three weeks later, and the seller kept the $250,000. Whether it was entitled to turned on which of two words the agreement had used, months before anybody knew there would be an argument.
At a glance
A commercial printing business in the Golden Horseshoe, $6.9 million of revenue and $780,000 of normalised EBITDA, sold on a share basis at $4.1 million to a strategic acquirer two towns away. The agreement was signed in March with a July closing and a financing condition running to the end of May.
$250,000 was paid to the seller’s counsel in trust on signing. The agreement described it in three places, and not consistently: clause 2.3 called it “the Deposit”; clause 2.4 said it would “be credited against the Purchase Price on Closing”; and clause 9.2, the remedies clause, said that on the Purchaser’s failure to complete, the Deposit “shall be forfeited to the Vendor as its own absolute property” without prejudice to any other remedy.
The buyer waived the financing condition on 30 May on the strength of a credit approval letter. On 21 June its lender withdrew after a covenant issue surfaced on the buyer’s existing facilities. There was no condition left to fail. The buyer asked for sixty days, the seller refused, closing did not happen, and the seller instructed counsel to release the $250,000.
The buyer’s position was that the payment was in substance a part payment of the price — clause 2.4 said so — and that forfeiting it was a penalty. The seller’s position was that clause 9.2 characterised it as a true deposit, forfeitable regardless of loss. The argument is entirely about characterisation, and characterisation was fixed by drafting done in March.
$250,000 on a $4.1 million price is 6.1%. The seller remarketed and sold four months later at $3,850,000 — a $250,000 shortfall — and incurred $71,000 of additional professional fees and four months of a distracted management team. So on these facts the seller could in fact demonstrate a loss at least equal to the deposit, which took the most attractive part of the buyer’s argument away.
No statute decides whether a payment is a deposit or a part payment. That question is answered by the agreement’s own language and by the common law, and it is the first question, because everything else follows from it. What the statute book supplies is the relief valve. Section 98 of Ontario’s Courts of Justice Act reads, in full: “A court may grant relief against penalties and forfeitures, on such terms as to compensation or otherwise as are considered just.”
The Court of Appeal for Ontario set out how that discretion is exercised in Redstone Enterprises Ltd. v. Simple Technology Inc., 2017 ONCA 282, where a buyer forfeited a $750,000 deposit on a $10,225,000 purchase. The application judge had relieved against forfeiture and reduced it to $350,000; the Court of Appeal restored the full amount. Two steps: whether the forfeited deposit was out of all proportion to the damages suffered, and whether it would be unconscionable for the seller to retain it.
On the first step, the decision disposes of the argument the buyer here wanted to run: “Since the appellant provided no evidence of damages, it is fair to infer that it suffered none.” And then, immediately, that alone does not render the forfeiture unconscionable. Absence of loss is not the test.
On the second, the Court described the exercise as one of context rather than arithmetic: “The analysis of unconscionability requires the court to step back and consider the full commercial context.” It held that “the finding of unconscionability must be an exceptional one, strongly compelled on the facts of the case”, and listed the indicia — “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”.
The reason a deposit is treated differently from every other stipulated sum is set out in the same decision, quoting the British Columbia Court of Appeal: “A true deposit is an ancient invention of the law designed to motivate contracting parties to carry through with their bargains.” The Privy Council formulation quoted at paragraph 27 puts the exception plainly — “the forfeiture of such a deposit (customarily 10 per cent of the contract price) does not fall within the general rule” that a sum payable on breach is a penalty unless it is a genuine pre-estimate of loss. On quantum the Court declined to fix a percentage, noting only that the deposit before it was slightly more than 7% and that there was no evidence this was commercially unreasonable.
The fork is a break fee, and it reverses who has to prove what. A break fee is not forfeited property held by the other side; it is a payment obligation. It is therefore tested as liquidated damages against the penalty doctrine and against unconscionability, and the party who wants the money has to sue for it. The same decision records the modern preference: “should, if at all possible, avoid classifying contractual clauses as penalties” and, faced with a choice between penalties and forfeitures, favour the latter. With a deposit, the money is already out of the buyer’s hands and the buyer must establish grounds for relief. With a break fee, the money is still in the payer’s hands and the claimant must establish an entitlement. Same commercial intention, opposite burden.
The buyer’s counsel took the point that clause 2.4 undermined clause 9.2, then abandoned it once the seller produced the resale contract at $3,850,000. There was a loss, it exceeded the deposit, and the two-step test in Redstone could not be got past on either limb. The $250,000 was released to the seller ten weeks after the failed closing and the parties exchanged mutual releases.
The seller’s new agreement, for the resale, said one thing in one place: a deposit, forfeitable on default, not described anywhere as a credit or a part payment, with the credit-on-closing mechanic dealt with in the closing-adjustments schedule instead. See what a letter of intent should and should not fix and the glossary entries for break fee and letter of intent.
Had the seller drafted clause 2.4 as the operative characterisation rather than as a mechanical credit, the buyer’s part-payment argument would have had a document behind it, and a $250,000 forfeiture would have become a claim for proven damages — recoverable in principle, but only after establishing quantum, and against a buyer whose lender had just withdrawn. Collection risk turns a forfeiture into a lawsuit.
The tell is the same sum of money described two different ways in one agreement. “Deposit” in the payment clause and “credited against the purchase price” in the adjustment clause is how a forfeiture argument gets built for the other side. Characterise it once, in one clause, and handle the credit mechanically elsewhere.
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