Is a Deposit Consideration for a Contract?
This question keeps coming up, so let’s have a look at it.
There are a few things to consider when we are talking about a contract. First of all, you have to get it going in the first place. There are two choices here: either 1) a seal, or 2) consideration.
If both parties affixed seals to the document, that means, that they are really serious. This is not just talk. They are not discussing anything. This moves from a “gift” to a contract.
The next alternative in order to determine whether there is a contract (in the absence of seals) is consideration. In a simple non-executory contract, this will be the exchange of money in return for the goods. Essentially, this takes place simultaneously during the performance of the contract. Someone buys a ring from a jeweler, money is paid and the ring is delivered. We went very quickly from contract formation to contract performance and fulfillment.
An executory contract is one which must take place over a period of time. Something is to be done. The completion time will follow. So, if that’s the case, we do need some “evidence” that there was a contract in the first place. The answer here, will be consideration.
Both parties did something which is indicative of an agreement to be bound by their statements.
Consideration for a contract consists of :
- an act in return for an act,
- a promise in return for a promise, or
- an act in return for a promise.
Kindly note, this is a reciprocal arrangement, something in exchange or RETURN for something else. It doesn’t simply flow one way. If we have that “reciprocity”, then we have a contract being created.
When it comes to the ring and the jeweler, we have an “act for an act”. The ring was delivered in exchange for the payment of money.
When it comes to real estate, we are dealing (usually) with a “promise for a promise”. The Buyer agrees to pay the sum of one million dollars and the Seller agrees to convey the property to the Buyer in exchange. That’s an executory contract. The completion will take place sometime in the future, not now.
We could also have an act in exchange for a promise. Partial possession, or early possession might be made available to the Buyer. Rather than moneys being paid at the moment, the Buyer simply promises to make payment in the future. So, the Buyer takes possession now, and the Seller accepts the promise, in exchange for the delivery of possession, which has already taken place. Indeed, we have a contract here too, an “act (delivery of possession) in return for a promise (payment to follow”.
Now, we have to consider the confusing role of the deposit. It’s paid by the Buyer to a third party Trustee, not to the Seller. That’s not good! That won’t create a contract. In some cases, it’s not in the contract at all. It’s completely unnecessary. Assuming there is a deposit, if the deal doesn’t become unconditional, it goes back to the Buyer from the Trustee. That’s not good either. The other party to the contract never saw it. If there’s a breach by the Buyer, the Trustee will pay it to the Seller, and if the deal is completed, the Trustee will pay it over to the Seller. That actually seems to be a little better, but, of course, the other party is not seeing this money until the deal is over. That’s way too late for contract formation. We obviously have a timing issue here. That hardly creates the contract in the first place!
What about a non-refundable deposit, would that work? Yes, it actually would work. That’s an upfront payment made directly to the Seller, and it’s never, ever coming back. Really, it’s not a “deposit” at all, it’s an upfront payment on account, no strings attached. That would qualify as an “act” which would create the contract. Remember that we need something going both ways. So, partial payment works on behalf of the Buyer plus a promise for the payment of the balance later in exchange for the Seller’s promise to convey the property in the future. Calling this payment a deposit is really a misnomer. Truly, it’s not a deposit at all.
You can see that a “strings attached” payment to a third party Trustee is insufficient to create the contract with the Seller. If Bob placed the sum of one thousand dollars in his wife Mary’s account in order to show the Seller that he was serious; the Seller will reply, “good for you, but I need something more than that…what good is that to me…”.
Ultimately, if all goes well, the deposit funds will be used to complete the payment of the purchase price. That’s contract performance. That has nothing to do with creating the contract in the first place. In fact, it’s no longer the deposit, it’s “purchase money”. When it stood as a “deposit”, it didn’t create the contract, the two promises did. The deposit turns into “money” and that “money” is used to pay part of the purchase price. The money is part of the purchase price and it was previously part of the deposit, but it didn’t create the contract, it was part of contract performance, fulfillment, satisfaction or completion.
It all comes down to:
contract creation, and
- contract completion.
Brian Madigan LL.B., Broker