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Deposit bonds, bank guarantees and the sale of land

Feature Articles

Cite as: November 2012 86 (11) LIJ, p.40.

It is important to ensure vendors are not at risk when accepting deposit bonds and bank guarantees in lieu of cash deposits under off-the-plan contracts for sale of land. 

By David P Lloyd

A deposit bond is a type of unconditional performance bond, the characteristic of which is the liability of the bond issuer to pay, upon demand, a sum of money to the person in whose favour the bond has been issued, who is known as the “favouree”.1

A performance bond is sometimes styled as a guarantee, or bank guarantee when the issuer is a bank. However, it is not a true guarantee because the issuing party does not guarantee the performance of a contract by the person who procures the bond, as might be the case when, for instance, a director of a company guarantees the performance of a contract by the company. This type of guarantee is no more than an undertaking by the issuer to pay a certain sum of money to the favouree on demand, just like a deposit bond. For convenience, this article uses the term “deposit bond” as encompassing both deposit bonds and guarantees that constitute an undertaking to pay a certain sum of money on demand.

A typical form of performance bond was considered by the High Court in Wood Hall Ltd v Pipeline Authority:2

“The bank unconditionally undertakes and covenants to pay on demand any sum or sums which may from time to time be demanded in writing by the owner up to a maximum aggregate sum of one million five hundred thousand dollars ($1,500,000.00) to be held by the owner.”

The courts require strict compliance with the terms of performance bonds and any conditions of payment contained in them. In Reliance Developments (NSW) Pty Ltd v Lumley General Insurance Limited,3 Bryson AJ made these observations (at [42]):

“Rigid formality and unquestioning payment on compliance are the heart and soul of the Bond and central to its commercial function. Performance bonds, guarantee bonds and other documents with similar characteristics and commercial function are encountered from time to time in case law, and they are enforced strictly.”

In the context of contracts for the sale of land, a deposit bond is procured by the purchaser and given by the issuer to the vendor as favouree in respect of the amount of the deposit, or part of it, and as a substitute for payment of the relevant sum in cash. Deposit bonds are becoming more common in Victoria. They are particularly popular with off-the-plan purchasers, because the length of time which can elapse before settlement would otherwise “tie up” a cash deposit for a considerable period.

Whether they sit comfortably with contracts for the sale of land in Victoria is another matter. General condition 11 of the contract of sale of real estate prescribed by the Estate Agents (Contracts) Regulations 2008 (“the standard contract”) provides for the deposit to be paid either to the vendor’s estate agent, the vendor’s legal practitioner or conveyancer, or into a special purpose account in an authorised deposit-taking institution in the joint names of the purchaser and the vendor. This mirrors the requirements of Division 3 of Part 1 of the Sale of Land Act 1962 (Vic) (SLA). Deposit bonds do not rate a mention, either in the standard contract or the SLA.

A special condition dealing with the provision of a deposit bond is usually found in contracts for the sale of land where it is contemplated that one is to be given in lieu of a cash payment of the deposit, either in whole or part. In contracts for off-the-plan sales, the relevant special condition is usually in quite elaborate terms, and may need to address the situation where a supplied deposit bond has an expiry date.

An early case dealing with deposit bonds in the context of a sale of land was Prior v Kuji Pty Ltd.4 There, a special condition of the contract provided that the vendor would accept, as an alternative to payment of the full deposit in cash, a partial cash payment on the signing of the contract with the remainder of the deposit to be paid at settlement, and with the obligation to pay the remainder of the deposit being supported by “a bank guarantee in terms satisfactory to the vendor which bank guarantee shall be made available to the vendor upon the signing hereof”.

The purchaser argued that the use of the deposit bond was contrary to s23 of the Land Sales Act 1984 (Qld). This provision required all money paid by way of deposit under the contract to be paid to a solicitor or real estate agent or the public trustee, with the recipient to hold the money pending either the vendor or the purchaser becoming entitled to it pursuant to the terms of the contract or the provisions of the legislation.

The argument did not win favour, essentially because no money had actually been paid out pursuant to the deposit bond. The remainder of the deposit had not been paid and was not payable until completion, with the deposit bond simply supporting the obligation on the part of the purchaser to pay it.

Legislation

The SLA has for some years regulated the payment and holding of deposits under a contract for the sale of land. There are essentially two separate regimes: the stakeholding provisions relating to contracts in general, which are contained in Division 3 of Part 1; and the special provisions in s9AA relating to what the SLA describes as “prescribed contracts” for the sale of a lot on an unregistered plan of subdivision, known colloquially as an off-the-plan sale.

Sections 23, 24 and 25 of the SLA, in dealing with deposit money, refer to money “received” in the course of a transaction for the sale of land. It tends to follow that they do not stand in the way of a deposit bond being provided by a purchaser in lieu of a cash payment. The same may be said for s9AA, which speaks of “money paid”.

When a contract for the sale of land proceeds to settlement, the purchaser pays the full amount of the purchase price or so much of it as remains outstanding, and the deposit bond is no longer of any utility.

Where settlement does not occur on account of the purchaser’s failure to pay the sum due at settlement, the vendor will usually serve a termination notice on the purchaser with a view to bringing the contract to an end and forfeiting the deposit. Under the terms of the deposit bond, the vendor should be able to call for payment from the issuer when the contract ends in this way.

Where the purchaser purports to terminate the contract – perhaps on account of breach or misrepresentation by the vendor, or an unfulfilled contingent condition, or pursuant to a statutory right of avoidance – it may prove necessary for the purchaser to obtain injunctive relief restraining the vendor from making a call on the deposit bond pending resolution of the dispute between the parties as to which of them is ultimately entitled to the deposit money.

Prescribed contracts

A prescribed contract is defined in the SLA (s9AA(7)) as a contract for the sale of a lot on a plan of subdivision, whether certified or not, to anyone except a statutory body or authority if the plan has not been registered by the Registrar of Titles under the Transfer of Land Act 1958 (Vic).

Section 9AA of the SLA provides, in sub- s(1), that a person must not sell such a lot unless, among other things, the contract of sale provides that the deposit money is to be paid to a legal practitioner, conveyancer or licensed estate agent acting for the vendor, to be held by that person on trust for the purchaser until registration of the plan of subdivision. Sub-s(2) provides that the deposit money paid by the purchaser must be paid to the legal practitioner, conveyancer or licensed estate agent acting for the vendor. By sub-s(6), deposit money includes all money received by the vendor or on behalf of the vendor before completion of the contract.

The legislation provides a significant sanction for non-compliance in s9AE(1):

“If the vendor under a prescribed contract of sale of a lot fails to comply with s9AA . . . the purchaser may rescind the contract of sale at any time before the registration of the plan of subdivision.”

It is noteworthy that the statutory avoidance right given by s9AE(1) is in absolute terms. In other words, the right is not qualified in the same way that, for example, a purchaser’s avoidance right on account of a defective vendor’s statement under s32(5) of the SLA is qualified by s32(7). Moreover, any ulterior motive of a purchaser in exercising the right is an irrelevant consideration.5

The sanction for non-compliance with the deposit regime is unique to prescribed contracts. There is no avoidance right in the case of non-prescribed contracts.

Everest Project Developments Pty Ltd v Mendoza6 (“Everest”) provides an illustration of the application of s9AE(1) of the SLA in circumstances where a deposit bond was provided by the purchaser under a prescribed contract of sale. In that case, various contracts of sale for lots on an unregistered plan of subdivision provided for the payment of a deposit, in cash as to part on the signing of the contract, and with the rest to be dealt with by way of a deposit bond. A special condition in each contract permitted the vendor to claim on the deposit bond if certain events were to occur. Some of those could potentially occur prior to registration of the plan of subdivision. In particular, by special condition 15.5 the vendor was entitled to draw on the deposit bond if the purchaser were to breach special condition 15.3. In turn, special condition 15.3 required the purchaser to pay the deposit in cash on the first to happen of various events. Apart from the settlement date, these included the date being 30 days before the deposit bond was to expire by time, and the date on which the deposit bond became “ineffective”.

It was held that special condition 15.5 contravened s9AA of the SLA, with the consequence that the purchasers were entitled to rescind the contracts under s9AE(1), as they had done. The reason was relatively simple: a demand might have been made under the deposit bond by the vendor pursuant to special condition 15.5 in one of the circumstances described in special condition 15.3 on a date prior to registration of the plan of subdivision, with the consequence that the deposit money might have been paid directly to the vendor in breach of s9AA.

A solution?

The result in Everest is a cautionary tale for vendors of lots on unregistered plans of subdivision. Can it be avoided in the future, and if so, how?

Might one possibility be to have the deposit bond issued in favour of the vendor’s legal practitioner? There is a practical difficulty with such a course of action. Performance bonds are generally issued at the request of the issuer’s customer and in connection with a contract or agreement between the customer and the favouree. No such contractual arrangement would exist between the customer as purchaser and the vendor’s legal practitioner. The arrangement is, of course, between the purchaser and the vendor only. And what would happen if the vendor were to change solicitor during the course of the contract?

In any event, and more to the point, it is not the identity of the parties to the deposit bond or the terms of the deposit bond which are potentially problematic for a vendor under a prescribed contract. Rather, it is the terms of the contract of sale itself insofar as they relate to the provision of the deposit bond and how it is to be dealt with.

In this regard, certain observations of the learned judge in Everest (at [83]) are of some significance:

“[R]eliance was placed on the fact that some of the deposit bonds . . . contain a provision that a claim cannot be made on the bond unless and until the contract of sale has been terminated in circumstances permitting Everest to forfeit or recover the deposit. However, the terms of the actual deposit bonds are not relevant in this context. The issue is whether the contracts, on their proper interpretation, provide that the deposit moneys payable by the purchaser may be paid otherwise than in accordance with s.9AA(1)(a). For this reason also, it is not the point that some of the deposit bonds provided by the defendants to Everest provided that the bond issuer would pay the moneys demanded ‘to or at the direction of the vendor’ or ‘to the person nominated in the contract of sale to hold the deposit’. Under the terms of the definition of ‘Deposit Bond’ it was open to Everest to require, or accept, a deposit bond which did not contain such conditions.” (emphasis added)

A similar comment had been made a decade before in Prior v Kuji Pty Ltd:7

“It is not in my view helpful to consider the nature of the arrangement between the bank and the [vendor] when considering the nature of the arrangement between the [purchasers] and the [vendor] which that bank guarantee supports.”

It would seem, then, that it is within a vendor’s control to ensure that the contract of sale, when dealing with the provision of a deposit bond in lieu of a cash deposit either in whole or in part, contains terms which do not have the potential to offend s9AA of the SLA.

In particular, the vendor should be wary of a term of the contract which opens up the possibility of the deposit bond being drawn upon by the vendor while the contract is still on foot and at a point in time prior to registration of the plan of subdivision – for instance, where a deposit bond is limited by time and is about to expire – with the funds being paid to the vendor rather than to the vendor’s solicitor to be held on trust for the purchaser pending registration of the plan.

It is of no relevance that the vendor might take care to pay any received money over to its solicitor to be so held. As noted in Everest by the learned judge (at [111]):

“[A]nother less scrupulous developer using the same structure [of the contract concerning the provision of deposit bonds] could legally receive proceeds of a deposit bond prior to registration of the plan of subdivision, and deal with those proceeds so as to take them out of reach of the purchaser in the event that the plan of subdivision is not registered and the purchaser becomes entitled to a refund of the deposit.”

It is another matter altogether if the contract has been lawfully terminated by the vendor on account of default on the part of the purchaser. In such a scenario, the vendor is immediately entitled to the deposit money by virtue of s9AF of the SLA and can make a call on the deposit bond.

Some vendors draw the relevant contract terms in such a way that this is the only basis upon which the deposit bond may be called up by them. They also make it an event of default under the contract for the purchaser to fail to replace a deposit bond which has an imminent expiry date with a new one at least a month or so before expiry to allow sufficient time for the vendor to terminate the contract on account of breach by the purchaser and then make a demand under the deposit bond while the bond is still current.



DAVID P LLOYD is a member of the Victorian Bar and a member of the Property Committee of the LIV Property and Environmental Law Section. The author is grateful for the many helpful suggestions made by Wai-Hwoon Low, a partner of Russell Kennedy and member of the Property Committee.

1. See generally Phillips, The Modern Contract of Guarantee, English edn, at 13-12ff; Andrews & Millett, Law of Guarantees, 6th edn at 16.01ff; Rowlatt on Principal and Surety, 6th edn at 17.01ff.

2. (1979) 141 CLR 443.

3. (2008) NSW ConvR 56-213.

4. (1992) Q ConvR 54-423.

5. Tudor Developments Pty Ltd v Makeig (2008) ANZ ConvR 8-041.

6. (2009) V ConvR 54-755.

7. Note 4 above, at 59,266.

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