Deposits are generally a necessary part of real estate transactions. Once the purchaser and the vendor agree to terms in an Agreement of Purchase and Sale, the purchaser is then usually required to deliver a deposit to the vendor’s real estate brokerage shortly thereafter. The deposit is held, in trust, by the real estate brokerage pending the closing of the transaction.
Provided that the transaction closes as scheduled in the Agreement of Purchase and Sale, the deposit is then released to the vendor by the vendor’s real estate brokerage. When the transaction doesn’t close is when problems and uncertainty surrounding the deposit can arise.
In 2006, the Registrar of the Real Estate Commission of Ontario1 (“RECO”) released a Bulletin on this topic, entitled “Failed Agreements of Purchase and Sale Return of Deposits”.2 This Bulletin states that in the case of a failed transaction there are only two very specific circumstances for when a real estate brokerage may release a deposit. They are as follows:
- In accordance with a release or direction signed by all parties to the Agreement (Mutual Release; or
- Upon receipt of a direction from the court (a Court Order).
Although funds are held “in trust” by a real estate brokerage, the common law has stated that this does not create the same type of trust relationship as when a lawyer holds fund, in trust, for a client. When a lawyer hold funds in trust, it is clear who the beneficiary is – the client; however, when funds are held in trust by a real estate brokerage, the beneficiary is unclear – it could be the vendor and it could be the purchaser.
The beneficiary of the funds in a failed transaction depends on the circumstances surrounding the transaction’s failure. Transactions fail for many reasons. Some common reasons are:
- The purchaser was unable to pay the balance of the purchase price on closing;
- The purchaser refused to waive a condition for her benefit;
- There was a material misrepresentation made in the Agreement of Purchase and Sale (i.e. zoning); or
- There is an encumbrance affecting title that cannot or will not be resolved by the vendor prior to closing (i.e. a writ of execution has been filed with the local sheriff and subsequently registered against title).
Sometimes, the beneficiary of the deposit is clear (i.e. generally, if the purchaser refuses to waive a condition to her benefit within the timeframe noted in the Agreement the vendor should agree to sign a mutual release and return the deposit to the purchaser). Other times it may not be so evident as to who is beneficially entitled to the deposit. For instance, consider a property occupied and shown to prospective purchasers as a triplex. Section 10 of the Agreement of Purchase and Sale addresses zoning and the realtors vaguely describe the property as “residential” (this is common). Upon the purchaser’s lawyer’s review of title and the municipal zoning by-law, the lawyer points out to her client that only single family residences and duplexes are permitted in this part of town. The purchaser decides that they do not want to operate a triplex contrary to the municipal by-law, nor do they want to close on the property and operate it as a duplex. As such, the purchaser requests their agent to inform the vendor that the purchaser is terminating the transaction pursuant to section 10 of the Agreement and to demand the return of their deposit. The vendor responds: “no, I only represented to you that this property was zoned residential, which is, in fact, correct.” The vendor refuses to sign a mutual release and a dispute ensues. In this scenario a real estate brokerage holding funds in trust, is not appropriately equipped to determine who may or may not be entitled to the deposit, and a court order is justifiably required.
While the signing of a mutual release or a court order seems to be a fair resolution to sometimes difficult problems, it also leaves the vendor in a position of power when a transaction fails to close. Consider a purchaser who inserts a clause into the agreement, for her benefit, to receive financing on terms satisfactory to the purchaser within five days of execution of the Agreement (this is a common condition in favour of purchasers); the purchaser is ultimately unable to secure financing acceptable to them and informs the vendor that they will not be waiving this condition, bringing the agreement to an end. Unfortunately, without the vendor’s agreement or a court order, the purchaser cannot have the deposit returned to her. Retaining a lawyer to make an application for a court order, when contested by the vendor, can cost $25,000.00 (or more) and there is no certainty to the outcome of the litigation. The result is that the purchaser is attempting to enforce a condition for her benefit, as agreed to by the vendor, but is not able to do so through simple means (if the vendor refuses to sign a mutual release, the purchaser’s only option is to commence legal proceedings). This gives the vendor an advantage. The vendor has the opportunity to essentially charge the purchaser for the mutual release – “rather than retaining a lawyer to pursue a court order on your behalf, you can pay me (the vendor) $5,000.00 and I will sign the mutual release.” While this tactic seems shrewd, it is a reality that purchasers may encounter.
Don’t Give Over-Sized Deposits
In today’s real estate market, purchasers are going to great lengths to compete for properties where multiple offers seem to be the norm. A common tactic is to increase the size of the deposit in an effort to emphasize to the vendor that the purchaser is intent on completing the transaction. However, many purchasers don’t realize that it can be quite difficult to recover their deposit, even if they terminate the Agreement for appropriate cause (i.e. a title objection that cannot or will not be rectified by the vendor prior to closing). When signing Agreements of Purchase and Sale, purchasers must realize that although they may have a clear right to the return of their deposit if the transaction fails to close, enforcing their right may not be so straightforward.
Consider Staging Deposits
Purchasers should also consider staged deposits. Typically, there would be an initial, smaller deposit provided on execution of the Agreement of Purchase and Sale and a second, larger deposit once all of the conditions are satisfied and the purchaser’s lawyer has had an opportunity to review title and documents ancillary thereto. The staged deposit strategy permits the purchaser to provide the majority of the deposit once the due diligence phase of the transaction is complete.
Use Interest-Bearing Trust Accounts
Purchasers should also ensure that Schedule A provides that their deposit is to be held in an interest-bearing trust account whereby all accrued interest (less the realtor’s brokerage’s administration fee) will be paid to them if they are successful in having their deposit returned.
Intend to Complete the Transaction
A purchaser should not rely on the conditional components of the Agreement of Purchase and Sale to walk away from a transaction unscathed. Certain conditions may be in the agreement for the purchaser’s benefit, and the purchaser may rely on them in appropriate circumstances; however, any real or perceived disingenuous reliance on such conditions may launch the deposit into an uncertain limbo where the vendor initially has the upper-hand.
1RECO is the Ontario based regulating authority for realtors.
— This entry was authored by Scott G. Lemke
Information herein is NOT legal, financial or investment advice. Should you have questions with respect to the information herein, please contact Lemke Law Professional Corporation.