Deposit forfeiture ruling boon for real estate sector

By Vivek Vashi and Aditya Sikka, Bharucha & Partners
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In the recent case of Satish Batra v Sudhir Rawal, the Supreme Court considered the issue of whether the seller of immovable property is entitled to forfeit the entire earnest money (advance payment or deposit) in cases where the transaction falls through by reason of the purchaser’s failure or neglect.

Vivek Vashi Bharucha & Partners
Vivek Vashi
Bharucha & Partners

In this case, the agreement between the purchaser and seller provided: (a) that the earnest money would be forfeited in the event of a default by the purchaser; and (b) the purchaser would be entitled to a sum equal to double the earnest money on a default by the seller.

Due to the purchaser’s default in payment of the balance owing, the entire earnest money was forfeited. The purchaser filed a suit challenging the forfeiture. The matter eventually reached the Supreme Court, which held that the entire earnest money may be forfeited when the transaction falls through due to default of the purchaser but only if the agreement clearly provides for this.

The forfeiture of earnest money by the purchaser in cases of default is incorporated in agreements for sale as a standard practice by real estate developers. The rationale is that construction and development are capital intensive, and timely payments by the purchasers are required to enable projects to proceed on schedule.

This is a welcome decision for the real estate business in India, which presently facing diverse challenges, including consumer activism.

Earlier cases

The Supreme Court in the Satish Batra case extensively discussed authoritative precedents on the issue of forfeiture of earnest money. The first of these was Chiranjit Singh v Har Swarup (1926), in which the Privy Council held that “earnest money is part of the purchase price when the transaction goes forward; it is forfeited when the transaction falls through by reason of the fault or failure of the vendee”.

Aditya Sikka Associate Bharucha & Partners
Aditya Sikka
Associate
Bharucha & Partners

The court then examined the principles set forth by the Supreme Court in Shri Hanuman Cotton Mills v Tata Aircraft Ltd (1969) regarding the nature of earnest money: “(1) It must be given when the contract is concluded. (2) It represents a guarantee that the contract will be fulfilled or, in other words, ‘earnest’ is given to bind the contract. (3) It is part of the purchase price when the transaction is carried out. (4) It is forfeited when the transaction falls through by reason of the default or failure of the purchaser. (5) Unless there is anything to the contrary in the terms of the contract, on default committed by the buyer, the seller is entitled to forfeit the earnest.”

Further, the court also discussed the Supreme Court’s view in Videocon Properties v Dr Bhalachandra Laboratories (2003), that: “Earnest money or deposit … serves two purposes of being part payment of the purchase money and security for the performances of the contract by the party concerned, who paid it.”

Court’s findings

On analysing these decisions, the court held that the entire earnest money may be forfeited when a transaction cannot be completed by reason of the fault of the purchaser. However, such forfeiture would only be possible if the express terms and conditions of the agreement contain such a stipulation, as in the Satish Batra case.

The court further noted that if an agreement is terminated due to a default by the seller, the purchaser may be able to recover up to double the amount of the earnest money but, again, only if the express terms of the agreement so provided.

Impact on developers

In the real estate industry, purchasers are generally required to make payments on the completion of each stage of construction. These stages are specified in the agreement for sale. As a safeguard, real estate developers seek advance payment in the form of earnest money to be paid prior to or on entering into an agreement for sale. The balance owing is then paid in instalments. On the purchaser’s failure to make payments, the developers are entitled to terminate the agreement and retain the amounts paid as earnest money. This ensures that the purchasers make future payments in accordance with the agreement.

Disgruntled purchasers whose agreements are terminated and earnest money forfeited usually seek recourse under consumer protection laws. It is unfortunate that forums for consumers such as the Competition Commission of India and state or district consumer forums have usually sided with the purchasers while declaring that such a practice is an unfair trade practice or that it amounts to anti-competitive behaviour.

The ruling in the Satish Batra case will provide legitimacy to this practice and some respite for aggrieved developers. Developers looking to safeguard their position must structure their agreements to reflect the principles set forth in this case.

Vivek Vashi is the mainstay of the litigation team at Bharucha & Partners where Aditya Sikka is an associate.

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