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Pre-incorporation Contracts -- Forfeiture of Deposit

Another recent case involved a pre-incorporation contract using the usual “[Buyer Name] in trust for a company to be incorporated and without personal liability” in order to protect the buyer from all liability. The focus in this case however was the forfeiture of a $100,000 deposit after the buyer advised the seller that he would not be completing the contract yet demanded return of the deposit.

The court accepted these principles of law:

(a)   A deposit stands on its own apart from the APS. It is an “ancient invention” designed to motivate parties to complete the APS. It is a form of security for the performance of a contract.

(b)   Unless there are clear words to the contrary, there is an implied term of the deposit that it is forfeited to the seller if the buyer fails to perform the contract.

A fundamental of corporate law is found in s. 21 of the Business Corporations Act which states that a person contracting for a company to be incorporated is, before the corporation’s existence, personally liable on the contract unless there are words expressly excluding personal liability.

The result of this law is that a seller would have no recourse for a breach of contract because no corporation had assumed the contract and the nominal buyer has excluded his liability by including the words “without personal liability”. However, the court found that the deposit is to be viewed and treated differently than the obligations under the contract. Without words to the contrary, the implied term of forfeiture of the deposit stood and resulted in this case with the seller retaining the full deposit of $100,000.

The court went on to emphasize that the implied term of forfeiture of the deposit can be eliminated by the use of clear terms which would oblige the deposit holder to return the deposit in full to the buyer if the contract is not performed.

This very recent case is important in that it is a decision of the Ontario Court of Appeal and, if it is not appealed, will stand as a very important legal decision for real estate professionals.

TOPICS FOR DISCUSSION

1.      OREA APS Form 100 has one paragraph dedicated to the “Deposit”. It is silent on the issue of forfeiture opting instead to state the deposit is “to be held in trust pending….other termination of this Agreement”. How do you answer the question from clients on both sides: what happens to the deposit?

2.      In cases such as this one where there has been exclusion of the buyer’s personal liability, would it be advisable for the buyer to expressly require the return of the deposit if the contract is not performed for any reason whatsoever?

Andrea DeRubeis