An option fee is paid for the grant of a real estate option. Normally, the option fee is credited towards the deposit under the Contract for Sale.
Even though it is treated as a deposit, does the option fee become a deposit that a purchaser can request be refunded if the vendor defaults under the Contract for Sale and the purchaser terminates the Contract?
According to the Court of Appeal (Supreme Court of New South Wales) in J&Z Holding (Aust) Pty Ltd v Vitti Pty Ltd [2024] NSWCA 2 (Griffiths AJA, Payne and Kirk JJA agreeing) (30 January 2024), the answer depends on the drafting of the option and the Contract for Sale.
This analysis covers the Court of Appeal’s decision, and also the interesting observations made by the primary judge (Lindsay J) in J & Z Holding (Aust) Pty Ltd v Vitti Pty Ltd [2022] NSWSC 1718 (20 December 2022) that the notice to complete was invalid.
Factual Background
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On 17 August 2018, Vitti granted J&Z an option to purchase the property at 562-576 Harris Street, Ultimo, an inner suburb of Sydney, (see image) for the price of $10,250,000. The option was a put and call option. The call option was exercisable by the purchaser within 22 months, expiring on 17 June 2020. The put option was exercisable by the vendor (the owner), within 5 days after the call option expired. The call option fee was $2,050,000 (20% of the price), payable by four equal instalments at six monthly intervals. |
562-576 Harris Street, Ultimo (The property at the centre of the NSW Court of Appeal decision in J&Z v Vitti)
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An Amending Deed was entered into to extend the call option expiry date to 17 January 2021, subject to payment of two “extension fees” totalling $220,000.
All the call option fee instalments and the extension fees were paid.
By January 2021, the property value had fallen substantially due to the COVID-19 pandemic. J&Z did not exercise the call option. In turn, Vitti (as owner) exercised the put option. A Contract for Sale came into existence at a price of $10,250,000, with the option fee of $2,050,000 ‘comprised’ the deposit.
The purchaser failed to complete the Contract for Sale on the due date of 30 June 2021. The vendor issued a Notice to Complete on 2 July 2021 which made time of the essence. The purchaser did not complete the Contract.
Both vendor and purchaser served notices of termination of the Contract for Sale, on or about 23 August 2021.
The vendor resold the property in July 2022 for $7,900,000 as a development site. The price represented a shortfall of $2,350,000 compared with the price under the Contract for Sale.
On settlement of the sale, the sum of $2,050,000 was paid into court by agreement, as both vendor and purchaser claimed an entitlement to that sum.
The dispute
The vendor claimed that the option fee never changed character to become a deposit, even though it was credited as a deposit. The vendor said that it always remained an option fee which it could keep. But if that argument failed, and it was a deposit, then clause 9 of the Contract for Sale applied and the vendor was entitled to keep the deposit because the purchaser had failed to comply with the Notice to Complete:
Cl 9 If the purchaser does not comply with this contract (or a notice under or relating to it) in an essential respect, the vendor can terminate … [and] keep or recover the deposit (to a maximum of 10% of the price) [and] hold any other money paid … as security for anything recoverable under this clause.
The purchaser claimed that the option fee had changed character and had become a deposit. And, because purchaser alleged that the vendor had wrongly repudiated the Contract for Sale because it relied on an invalid Notice to Complete to terminate the Contract for Sale, clause 8.2 of the Contract for Sale applied and it was entitled to recover the deposit:
Cl 8.2 If the vendor does not comply with this contract (or a notice under or relating to it) in an essential respect, the purchaser can terminate … [and] recover the deposit and any other money paid by the purchaser under this contract.
The Court of Appeal – Did the option fee become a deposit?
The Court of Appeal examined the documentation to decide whether the call option fee had become a deposit, in three potential scenarios:
(a) Call Option is exercised
The Court of Appeal said:
Vitti granted J&Z “an exclusive right to purchase during the Option Period, in consideration of the purchaser’s payment of the first instalment of the Call Option Fee”.
The Call Option constituted “an irrevocable offer” by the vendor to sell the property.
The first two instalments of the Call Option Fee (up to 10% of the price):
"shall be taken to form and constitute the deposit payable under the Contract and shall be subtracted from the purchase price payable at completion of the Contract."
The primary judge said:
“The expression “taken to form and constitute” presents itself as a deeming provision predicated upon a recognition that payments were made in the character of an option fee rather than as instalments of a deposit.”
The Court of Appeal agreed:
“this provision amounts to a deeming provision in the sense that the first two instalments had the character of an option fee, but were then deemed also to have the character of a deposit. This is not unimportant, because it illustrates that, because of the deeming provision, the instalments had the dual character of being an option fee as well as a deemed deposit.”
The Court of Appeal concluded that the call option fee did not change character when the call option was exercised. It did not become a deposit. It “remains [the vendor’s] property”.
This was despite additional clause 41.1 of the Contract for Sale which stated that “the deposit is released to the vendor”. The “looseness in language is manifest”: there was no deposit to be released to the vendor, because it was only a deemed deposit, not a deposit paid and which could be released.
(b) Call Option is not exercised
The Court of Appeal said:
The Option Agreement states “the [vendors] keep all amounts paid as the Call Option Fee” if the Call Option is not exercised.”
“The vendor’s right to “keep” the Call Option Fee where the Call Option is not exercised strongly indicates that the relevant amount is consideration for the grant of the option, and not simply a conventional deposit.”
“These provisions operate to permit the [vendors] to keep the Option Fee not only if the Option is not exercised, but also where, subsequently, the vendors exercise the Put Option so as to create the Contract.”
(c) Put Option exercised
The Amending Deed provided that:
“the Call Option Fee is and has been irrevocably and unconditionally forfeited and released to the [vendors]”; and
“ïf the Contract is exchanged pursuant to the Option Deed, the Call Option Fee will comprise the Deposit payable under the Contract.”
The Court of Appeal said:
“the Call Option represented a credit in the [purchaser’s] favour against the purchase price payable .. on completion, as opposed to being a conventional deposit”.
“the Amending Deed operated to increase the amount of the “deposit”… from 10% to 20% … [As a] consequence … the purchaser obtained a credit in the full amount of the Call Option Fee.”
“merely because the disputed sum is described in various parts of the documentation as “the deposit” is not determinative of its true legal character … [particularly] here, given the acknowledged poor drafting”.
“the disputed sum [represented] the consideration … for the grant of the option.”
The appeal was dismissed with costs.
The Court of Appeal did not deal with the wrongful repudiation / notice to complete issue because of its conclusion that the “disputed sum” was “the consideration for the grant of the option”.
Comment
There was no reason why the option fee was referred to as a ‘deposit payable under the contract”. A ‘conventional deposit’ is completely different from an option fee. A conventional deposit is a sum paid as security for the purchaser’s performance of the Contract.
The drafting confusion could have been removed had the drafter put a line through the “deeming”, that is:
“the call option fee shall be taken to form and constitute the deposit payable under the Contract and shall be subtracted from the purchase price payable at completion of the Contract”.
Make it a rule to avoid using “deposit” interchangeably with “option fee”.
The primary judge – was the Notice to Complete invalid?
Notices to Compete are a commonplace conveyancing procedure to bring completion under a Contract for Sale to a head by making time of the essence.
These observations made obiter by His Honour Justice Lindsay illustrate the importance of specifying the right date for a Notice to Complete is to expire.
The Contract for Sale contained special condition 37:
“If this contract is not completed [on the completion date], the party not in default may serve a notice … making time of the essence in respect of completion both at law and in equity requiring the other party to complete this contract within a period of at least 14 days after service of the notice. … This notice may be withdrawn at any time.” (with emphasis added)
On Friday 2 July 2021, the vendor served a notice to complete on the purchaser which stated:
“you are required to complete the sale on or before 3:30 pm on Friday 16 July 2021 and in this respect time is of the essence for the completion of the contract”
His Honour Justice Lindsay said:
“The notice to complete was invalid because, allowing for a weekend, it did not provide fourteen clear days for completion as required by special condition 37 … To be valid, the notice was required to specify a time for completion no earlier than Monday 19 July 2021.”
The purchaser pointed out this defect in the notice to the vendor, but the vendor insisted that the notice to complete was valid. The vendor could have, but did not, withdraw the notice and issue a new notice with a new date. Instead, the vendor relied upon the notice to issue a Notice of Termination on 19 July 2021.
The purchaser challenged the vendor’s Notice of Termination by contending that “it was a wrongful repudiation of the Contract”, which the purchaser accepted.
His Honour Justice Lindsay agreed:
“I I find that the [vendor’s] wrongful termination of the contract on 19 July 2021, for the [purchaser’s] non-compliance with a notice to complete which was invalid, constituted a repudiation by the [vendor] of their obligations under the contract … and that the contract came to an end when the [purchaser] accepted that repudiatory conduct as putting an end to the contract.”
Therefore, had the purchaser succeeded in its claim that the option fee had changed character and had become a deposit on exercise of the option, it would have been able to recover the sum under clause 8.2 of the Contract after it accepted the vendor’s repudiation of the Contract for Sale.
Comment
There was no explanation as to why the vendor was so steadfast in relying on the Notice to Complete, instead of withdrawing it and issuing a new notice with one extra day. Perhaps they were influenced by the cooling off period expiry, which is at 5:00 “on the fifth business day after the day on which the contract was made” (s 66S(3) Conveyancing Act 1919 (NSW)).
The lesson is, when specifying a date for completion under a 14-day notice to complete, always specify an extra day - the first business day after the 14th day.