Contracts and Exchange — SQE1 practice question

A woman is selling her house at £420,000. Her buyer has asked to pay a deposit of 5 per cent rather than the 10 per cent the contract provides, saying that the rest of his money is tied up until his own sale completes. The buyer is himself in a chain and his own buyer has not yet exchanged. The woman is content, since she does not need the money before completion. Her solicitor asks her to think again before agreeing, and to consider what the deposit is actually for.

What should the solicitor explain about the function of the deposit here?

Option A. Incorrect answer. It is the seller's money from exchange, so a smaller sum leaves her short before completion.
Option B. Incorrect answer. It is paid towards the lender's advance, so a smaller sum increases the buyer's interest rate.
Option C. Incorrect answer. It is a payment on account of price only, so its size has no bearing on her remedies at all.
Option D. Incorrect answer. It must be exactly a tenth of the price, so any lesser figure makes the contract void.
Option E. Correct answer. It is her security if the buyer defaults, so a smaller sum leaves her less protected.Correct

Why

The correct answer is E. The deposit is not merely an early instalment of the price. It is an earnest of performance: a sum the buyer stands to lose if he fails to complete, which both concentrates his mind and puts a fund in the seller's hands if he walks away. If the buyer defaults and the seller rescinds after serving a notice to complete, the standard conditions entitle her to forfeit the deposit and to resell, recovering any further loss — a lower price on the resale, her wasted costs — by an action for damages in which the forfeited deposit is brought into account.

A reduced deposit weakens that in two ways. The obvious one is arithmetic: on a £420,000 sale, 5 per cent is £21,000 rather than £42,000, so the money actually in hand covers less of any loss. The subtler one is that the balance is not automatically hers. Recovering the shortfall depends on proving loss and on the buyer being worth suing, and a buyer who has defaulted because his own sale collapsed may well be worth nothing — which is a live risk here, since he is in a chain and his own buyer has not exchanged. If she is to accept 5 per cent, the contract should be varied by special condition so that the full 10 per cent becomes payable on default notwithstanding the smaller sum actually paid.

A is incorrect because the deposit is normally held by the seller's solicitor as stakeholder, not as the seller's money to use before completion. B is incorrect because the deposit is paid to the seller's side under the contract and has nothing to do with the buyer's lender or his rate. C is incorrect because, although the deposit is credited against the price on completion, its forfeitable character is the whole point of it. D is incorrect because the amount may be varied by special condition, and a lesser deposit does not affect the validity of the contract.