October 27, 2017

By Brian Babcock

In a recent article, I explained how the Ontario Court of Appeal had clarified the law of “relief from forfeiture.” Now, the Court has considered the importance of confidence that bargains will be enforced. This means that relief from forfeiture must be rare, and subject to defined principles.

Relief from forfeiture is a remedy which allows a judge to excuse imperfect compliance with a contractual or statutory requirement, upon terms that are fair to everybody affected, where the result is unfair to the party who made the error. In the case discussed in the prior article, the Court dealt with a situation of imperfect compliance with statutory deadline, and extended the time.

Now, the Court has had an opportunity to look at a case involving using relief from forfeiture under a contract- specifically, whether a deposit on a real estate deal gone bad would be forfeited to the seller, or whether the prospective buyer would be permitted to have the deposit returned.

In law, where money is held as a deposit, in most situations, the seller has an option, or election, to retain the deposit as “liquidated damages” or sue for actual damages. In some contracts, the seller may retain the deposit AND sue for additional damages. To protect buyers from harshly unfair results, the Courts have a rule that if the forfeiture is a “penalty” rather than “forfeiture”, it is not allowed. As a result, sophisticated agreements usually contain wording defining the deposit as being payable to the seller in the event of the deal not closing.

In Redstone Enterprises Ltd. V. Simple Technology Inc., the seller, Redstone Enterprises Ltd., sold a warehouse in Brantford to the buyer, Simple Technology Inc., for $10,225,000. When the buyer failed to complete the transaction, the seller applied for a declaration that it was entitled to be paid the deposit of $750,000, which was being held in trust by a realtor. The buyer opposed.

When the deal was first agreed to, the deposit was $100,000.00, with an additional $200,000.00 deposited upon waiver of certain conditions. When the buyer needed more time, it agreed, after negotiations, to deposit a further $450,000.00 to extend the closing date. The amending agreement stated that if the transaction was not completed, the full $750,000 would be paid to the seller.

The deal did not close. There was no evidence that the seller had suffered any actual damages or loss as a result of the deal falling through.

The Superior Court judge who heard the application ruled that since he could not say whether the forfeited amount was proportionate to the losses, the proposed amount forfeited was unconscionable and should be reduced to $350,000.00. He did not explain how he picked that amount.

The Court of Appeal relied on an earlier decision that dealt with stipulated or agreed damages (not deposits) which suggested that the policy of upholding freedom of contract means that:

• Courts should, if at all possible, avoid classifying contractual clauses as penalties.
• When faced with a choice between considering stipulated remedies as penalties or forfeitures, Courts should favour the latter.
• Courts should, whenever possible, favour analysis on the basis of equitable principles and unconscionability over the strict common law rule pertaining to penalty clauses, making case specific contextually decisions.

The Court of Appeal agreed that the judge applied the correct test, which has two steps:

1. whether the forfeited deposit was out of all proportion to the damages suffered, and
2. whether it would be unconscionable for the seller to retain the deposit.
   The Court of Appeal agreed that, since there was no evidence of any loss, it was fair to infer or assume that there were none. That satisfied the first step of the test.

However, that alone did not make the forfeiture unconscionable. Deposits are commonplace in the operation of the market, especially for larger assets such as commercial real estate. The purpose of the deposit is to motivate parties to honour their bargains. This purpose is consistent with forfeiture of the deposit, even if there are no damages. This rule regarding deposits is an exception to the general rule about penalties described above.

The Court then considered that prior cases had determined deposits of 10 per cent or even 20 per cent were reasonable, and could be forfeited. In the Redstone case, though large in absolute dollars, the deposit was only 7 per cent of the purchase price. Thus it was not disproportionate to the usual market bargains.

They went on to look for other indications that the deposit was unconscionable. As noted above, they felt it is important that this review reflect consistent principles, but because each case is fact and context specific, the list had to be somewhat flexible.

Prior cases suggest that the list of indicators of a shockingly unfair or unconscionable bargain includes:

• 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.

In the Redstone situation, the Court found that there was no unconscionability based on these factors. This was a straightforward commercial real estate deal involving two sophisticated parties with no inequality of bargaining power. The long closing date created a risk of market price fluctuation for both parties. Once a further extension was required, the risk to the seller increased, so it was reasonable of them to demand a higher deposit. Then later the buyer tried to back out raising spurious complaints, when it actually had financial and licensing hurdles to the proposed use of the building.

Thus, the Court concluded that the entire deposit of $750,000.00 was to be paid to the seller.

Although the principles of equity exist to relieve from unconscionable bargains, this case confirms that whether under equity or the statutory relief from forfeiture under the Courts of Justice Act, the Courts will still in most cases hold parties to their bargains.

Next time you sign a contract with a deposit clause, you should be aware of the likelihood you will forfeit it if you renege on your bargain.

If you are the seller, you should bargain for a deposit which adequately protects you from the risks of the deal with confidence that the Courts still believe in freedom of contract.