DAWSON ENTERPRISES LTD. v. TALISTEAM LTD.

M.P. No. 790/94

HEADNOTE

Conveyancing - contract for sale and purchase of land - incorporation of Condition 10, Part A, Second Schedule of Cap. 219 - confusion between deposit and liquidated damages - insufficient for forfeiture of deposit.

M.P. No. 790/94

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

MISCELLANEOUS PROCEEDINGS

________________

________________

________________

________________

J U D G M E N T

________________

1. This is a vendor and purchaser summons brought by the Plaintiff as confirmor against the Defendant as sub-purchaser. The Plaintiff seeks two declarations. First, that it has effectively rescinded the sub-sale and purchase agreement (the sub-agreement) dated 2nd March 1994 made between the parties. Second, that it was entitled to forfeit the deposit of $540,000 paid by the Defendant to the Plaintiff pursuant to that agreement. The Plaintiff also seeks an order that registration in the Land Registry as an incumbrance of a High Court Action taken by the Defendant in relation to the same matter be vacated.

2. On 14th February 1994 Grannis Limited (Grannis) agreed to sell to the Plaintiff (the principal agreement) Flat D, 1st Floor, Tower 14, Parc Oasis, Yau Yat Tsuen (the property). The price was $4,772,000. $715,800 were paid as deposit and part payment of the purchase money on the signing of that agreement. The balance was to be paid on or before 16th March 1994 which was the date provided for completion. In Clause 19, the principal agreement provided that time should be of the essence. Clause 20 continued :

" Should the Purchaser fail to observe or comply with any of the terms and conditions herein contained or if the Purchaser shall fail to make payment of any part of the purchase price (whether of the deposit or the balance of the purchase price or of any instalment thereof) on the date stipulated for payment of the same herein the Vendor may give to the Purchaser notice in writing calling upon the Purchaser to make good his default and in the event of the Purchaser failing within 21 days from the date of such notice fully to make good his default the Vendor may by a further notice in writing forthwith determine this Agreement and the Vendor shall thereupon be entitled to re-enter upon the Premises and repossess the same if possession shall have been given to the Purchaser free from any right or interest of the Purchaser therein and the Vendor shall be entitled to forfeit the said deposit and any instalments of the purchase price paid hereunder and received from the Purchaser as occupation rent a sum equal to interest at the rate of 15% per annum on the whole of the purchase price for the period during which the Purchaser was in occupation ...."

3. On 23rd February, the Plaintiff sold the property to the Defendant by way of preliminary sub-sale agreement, contained in one of the abbreviated forms of agreement commonly supplied by estate agents. The price was $5,400,000. $300,000 were paid on signing that agreement as deposit, and $214,000 was to be paid upon the signing of a formal agreement on 28th February as balance of deposit. Completion was to be on or before 12 noon on 16th March 1990.

4. On 2nd March, the Plaintiff and Defendant signed the sub-agreement and a further deposit of $240,000 was paid so that the total then paid by the Defendant was 10% of the purchase price. Completion was to take place at the Plaintiff's solicitors office, on or before 12 noon on 16th March. Time was to be of the essence of the agreement. Clause 17 of this agreement incorporated the conditions contained in Part A of the Second Schedule to the Conveyancing and Property Ordinance, Cap. 219 unless inconsistent with the provisions of the agreement. Clause 21 provided :

" It is hereby agreed that all benefits of the Vendor under the Principal Agreement shall be accrued to the Purchaser and all rights of the Vendor under the Principal Agreement shall be exercisable by the Purchaser."

5. No one appeared at the Plaintiff's solicitors office by 12 noon on 16th March to complete the sub-sale. At approximately 12:20 p.m., however, the Plaintiff's solicitors received by fax a letter from the Defendant's solicitors which reads :

" We refer to the Principal Agreement for Sale and Purchase of the captioned property and write on behalf of our clients to request you to postpone the date of completion from 16th March 1994 to 17th March 1994. Our clients will bear the interest incurred from this postponement.

Kindly take your client's instruction and revert to us at your earliest convenience."

6. The Plaintiff's solicitors replied by letter and fax at about 2:14 p.m. the same day. They said they had taken instructions. They drew attention to the provisions in the sub-agreement for completion on or before 12 noon and for time to be of the essence. They said that by the earlier letter the Defendant had evinced an intention no longer to be bound by the agreement and that they were instructed to accept the Defendant's repudiation of the agreement and to forfeit the deposit paid.

7. The Plaintiff, in the meantime, raised the funds necessary for it to complete the principal agreement. Under cover of a letter from the Plaintiff's solicitors, cashier orders or cheques for the balance of the purchase money were sent to the solicitors for Grannis Limited at about 3:45 p.m.

8. At 3:51 p.m., the Plaintiff's solicitors received by fax from the Defendant's solicitors a letter which left something to be desired. It read :

" We refer to your letter to us of even date.

Under Clause 21 of the Agreement for Sub-Sale and Purchase dated 2nd March 1993, our client shall be entitled to exercise your client's right in the Principle Agreement dated 14th February 1994, which include the right to be given 21 days notice to made good any

In this regard, our client is not strictly speaking in breach of the said Agreement for Sub-Sale and Purchase and your client is not entitled to forfeit our client's deposit.

Please be informed that our client undertakes to bear the interest payable by your client to the head Vendor only to the postponement of the completion.

All our client's rights are hereby reserved."

9. At approximately S:10 p.m., still on 16th March, the Plaintiff's solicitors received from the Defendant's solicitors a letter enclosing, by way of completion of the purchase, cheques totalling the balance of the purchase money. These cheques were returned to the Defendant's solicitors before 10:00 a.m. the following day, under cover of a letter in which the Plaintiff's solicitors enquired whether the Defendant's solicitors were instructed to accept the service of proceedings which would be taken out by the Plaintiff for appropriate relief. By way of reply, on 18th March the Defendant issued a generally endorsed writ being High Court Action 2581 of 1994 (the Action). By the endorsement, the Defendant (being of course the plaintiff in the Action) sought specific performance, damages, repayment of the deposit and other relief. The following day, the Action was registered as an encumbrance on land.

10. On 30th March, the Plaintiff commenced these proceedings. On 28th April, the Defendant took out an inter partes summons in these proceedings seeking a stay on the ground that there was already an action pending between the parties in relation to the same matter so that the originating summons was frivolous, vexatious and an abuse of process. Subsequently, the parties appeared before another judge. I am not entirely clear as to what took place before him but it seems that, as a result of advice which he gave, the Defendant issued a summons seeking consolidation of the two sets of proceedings. For hearing before me, therefore, were the Plaintiff's originating summons and the Defendant's summonses to stay these proceedings and for consolidation. I determined I should hear the originating summons first because, if the Plaintiff is successful, there will be an effective disposal of the proceedings between the parties.

11. The Plaintiff's case is simple. The Defendant failed to complete by the time stipulated when time was of the essence. The Plaintiff was entitled to treat failure to complete as repudiation of the contract and to rescind accordingly. It would follow that the deposit should be forfeited.

12. For the Defendant, Mr. Cheung raised three issues. First that the Defendant was arguably not in breach of contract. Second, that the court has jurisdiction to relieve a defaulting purchaser of land from forfeiture of his interest in the land and, for this purpose, the circumstances surrounding the breach of contract should be investigated. Third, that there should be no forfeiture of the money described as a deposit, it being a penalty and not a genuine deposit nor a genuine pre-estimate of loss constituting liquidated damages.

Was There Breach of Contract

13. In its reply and defence to counter-claim in the action, the Defendant avers that by its solicitors the Plaintiff by implication waived the time for completion on condition that the Defendant would pay the interest incurred by the Plaintiff in arranging short term loans to finance its own purchase. An affidavit in the Action by a director of the Defendant asserts that there is a genuine factual dispute as to whether the deadline for completion had been waived. The position, therefore, is that there was apparently a waiver but there is wholly lacking any explanation as to how that waiver came about. There is not, as I pointed out to Mr. Cheung, any evidence from the Defendant's solicitor to the effect that he had had conversation with the Plaintiff's solicitor which led him to believe that the deadline would be waived. Nor is there any such affidavit from a director or officer of the Defendant to suggest that an officer of the Plaintiff might have agreed to relax the time limit. The lack of such evidence, I said, posed great difficulties for the Defendant.

14. Mr. Cheung met them in this manner. He said that the Plaintiff's solicitors did not remind the Defendant's solicitors on the morning of 16th March that the deadline for completion was approaching. Very shortly after the deadline expired, the Defendant's solicitors asked for a postponement of completion until the following day. There was no response to that request for about two hours. The delay in replying in a situation which obviously called for urgency led the Defendant or its solicitors to the misapprehension that the Plaintiff was not so concerned about the strictness of the time limit as it subsequently insisted upon. Once the Defendant appreciated the gravity of the situation, it showed itself willing and able to perform the contract by producing the funds necessary to complete the purchase shortly after 5:00 p.m. The reference in the 12.20 p.m. letter to the Defendant bearing interest lends colour to this interpretation of events because of the Plaintiff's later action in raising funds.

15. That is an ingenious argument but, in my judgment, wholly lacking in any merit. The Plaintiff's solicitors, as Mr. Cheung acknowledges, were under no obligation to remind the Defendant's solicitors of the approach of the time for completion. Further, the fact that it took two hours for the Plaintiff's solicitors to obtain instructions and reply to the Defendant's request does not seem to me to be unreasonable. Appropriate directors or officers of the Plaintiff, who would be in a position to make decisions, would not necessarily be immediately available. What is more surprising to me is that, having received a clear and explicit reply, the Defendant's solicitors did not immediately attempt to tender the necessary purchase money if, as it is now asserted, the Defendant was able and willing to perform its contract. I fear that the unhappy Mr. Cheung was essentially trying to make bricks without straw.

16. Mr. Cheung's alternative submission was foreshadowed in the Defendant's solicitors letter sent at 3:51 p.m. on 16th March. The sub-agreement had the effect of assigning to the Defendant the rights and benefits accruing to the Plaintiff under the principal agreement. By Clause 20 of that agreement, the Defendant asserts that the Plaintiff had a contingent right to make good any default in payment on the date for completion within 21 days of notice by Grannis subject to payment of interest. Mr. Cheung suggested that there was somehow privity of contract between the Defendant and Grannis because of the references to the principal agreement in the sub-agreement and because it was plain that the Plaintiff was selling as confirmor. That was a somewhat startling proposition. It is without merit. Equally without merit is the submission that the Defendant was excused from complying with the time limit laid down in the sub-agreement because the Plaintiff might have a contingent right under Clause 20 of the principal agreement. The Defendant was under an obligation to perform under the sub-agreement. Had it done so and if the Plaintiff had been in default under the principal agreement and if Grannis exercised its option under Clause 20 to extend time for the Plaintiff to complete, then the Defendant could have taken advantage of that option (assuming that it wanted to pay for the property a second time pending a successful action against the Plaintiff for the Plaintiff's breach of the sub-agreement).

17. I am quite satisfied, therefore, that there is no defence available to the Defendant. It was in breach of contract.

Does the court have jurisdiction to relieve a defaulting purchaser of land from forfeiture of its interest in land

18. Mr. Cheung's submission was based upon two Australian cases. In Legione and Another v. Hateley (1982) 152 CLR 406, the High Court of Australia by a majority decided the court had jurisdiction to relieve a defaulting purchaser against forfeiture of his interest in the land, even where he had failed to comply with a condition of which time was of the essence. In their combined judgment, Gibbs C.J. and Murphy J., after a careful review and analysis of earlier decisions, said at page 429 :

" A court of equity will grant specific performance notwithstanding a failure to make a payment within the time specified by the contract if there is nothing to render such an order inequitable. The fact that time for the performance of the stipulated obligation is of the essence of the contract generally makes the grant of specific performance inequitable in such a case. However, if it is just to relieve against the forfeiture which is incurred when the vendor retains payments already made under the contract, it is difficult to see why it should be unjust to relieve the purchaser against the forfeiture of the interest in the property that results in exactly the same circumstances. No doubt where the parties have chosen to make time of the essence of the contract the grant of relief against forfeiture as a preliminary to an order for specific performance will be exceptional. Nevertheless on principle we can see no reason why such an order should not be made if it will not cause injustice but will on the contrary prevent injustice. If relief against the forfeiture is granted, the objection to the grant of specific performance is removed."

19. The judges then went on to evaluate the circumstances prevailing in that case and, given the circumstances, it is hardly surprising that they found that it would be "a harsh and excessive penalty for a comparatively trivial breach" to enforce the vendor's rights. Mason and Deane J.J. in their judgment said at page 448 :

" The foregoing discussion indicates that the Judicial Committee in Steedman v. Drinkle and Brickles v. Snell gave more weight to the value of enforcing contracts according to their strict terms and less attention to the fundamental principle which underlies the exercise of the equitable jurisdiction to relieve against forfeiture than we are disposed to give them. That the Judicial Committee did so is readily understandable because in the early part of this century overriding importance attached to the concept of freedom of contract and to the need to hold parties to their bargains. These considerations, though still important, should not be allowed to override competing claims based on long standing heads of justice and equity. The result of the two decisions was to enunciate an inflexible rule that specific performance will never be granted where there is a breach of an essential condition, thereby diminishing the utility of the remedy in cases of relief against forfeiture. A preferable course is to adjust the availability of the remedy so that it becomes an effective instrument in situations in which it is necessary to relieve against forfeiture of the purchaser's interest under a contract for sale. The rule would then be expressed by saying that it is only in exceptional circumstances that specific performance will be granted at the instance of a purchaser who is in breach of an essential condition."

20. The principle formulated in that case was followed in Stern and Another v. McArthur and Another (1988) 165 CLR 489, another decision of the High Court of Australia. What the latter decision did not do, however, was to determine the correct approach to what constitutes exceptional circumstances. In the earlier case, Mason and Deane J.J. said that relief will hinge upon the existence of unconscionable or unconscientious conduct on the part of the Plaintiff. Gibbs C.J. and Murphy J., however, seem to have expressed a broader test, namely "a harsh and excessive penalty".

21. Do those Australian decisions represent the law in Hong Kong? The only direct reference to them occurs in Gladflow Limited v. Grandland Development Limited (1993) 2 HKLR 494 where Godfrey J. said at page 501 :

" The court certainly can, in the exercise of its equitable jurisdiction relieve a purchaser against the operation of a penal stipulation in the contract under which the purchaser is to forfeit his interest under the contract: see e.g., Kilmer v. British Columbia Orchard Lands Limited [1913] AC 319. A stipulation such as that contained in clause 18 of the Agreement here for forfeiture of the purchaser's interest under the contract, and further for forfeiture of all instalments of purchase money already paid by the purchaser, is, in my judgment, a penal stipulation, notwithstanding the attempt to attach the label of liquidated damages to the penalty.

It is, therefore, open to this court to grant relief to the purchaser if it thinks it proper to do so. But should it do so in the instant case? Although it is open to the court to grant specific performance if the justice of the case requires it, even though the literal terms of a stipulation as to time have not been observed, it has been said that the court will "never exercise this jurisdiction where the parties have expressly indicated in their agreement that it is not to apply by providing that time is to be of the essence of the bargain" : see Steedman v. Drinkle [1916] AC 275, at p. 279, per Viscount Haldane, giving the judgment of the Privy Council.

Clause 17 of the Agreement bere did make time of the essence of, inter alia, the purchaser's obligation to pay the $940,000 on 18th June 1992. This court cannot, therefore, without departing from Privy Council authority, order specific performance at the instance of the purchaser in the present case. The most this court can do is to relieve the purchaser against the forfeiture of its deposit ...

During the course of the argument I drew the attention of counsel to the controversial decisions of the High Court of Australia in Legione v. Hateley (1983) 152 CLR 406 and Stern v. McArthur (1988) 165 CLR 489, from which it appears that the Australian courts might be prepared in an exceptional case to relieve against forfeiture, and go on to order specific performance in favour of the purchaser, notwithstanding a breach by the purchaser of a stipulation of which time was of the essence, if the vendor's insistence on its right to terminate the contract was in all the circumstances of the case unconscionable. But since I am not prepared to hold in the present case that the vendor's conduct can be so characterised, these Australian authorities are in the end of no help to the purchaser."

22. To combat this powerful submission, Mr. Chong for the Plaintiff referred me to the decision of the Court of Appeal Ip Ming Wai and Another v. World Ford Development Limited 1992 No. 187 (Civil) given on 2nd April 1993 but so far, I think, unreported. In that case, where time was of the essence, the purchaser defaulted by some 24 minutes and sought to rely upon the de minimis rule. That rule is of course one of equity. At page 7 of the judgment, Litton J.A. said :

" The first and fundamental rule is that the courts have no dispensing powers. When the parties are under no disability and have, with their eyes open, entered into a contract, the duty of the court is to give effect to it. When the parties have said that acts are to be performed "at or before 5 p.m.", this does not mean "at about 5 p.m.". Parties can of course contract for mutual tolerance, for example by agreeing that time is not of the essence of the contract. The latitude which the parties import into their own contract, by the words they themselves use, should not be confused with the "de minimis" rule :

see Louis Drevfus v. Parnaso (1960) 2 QB 49"

23. After reviewing the authorities and the evidence in the case, the judge concluded :

" But if, factually, it is beyond all dispute that one or other of the parties was in truth a few minutes late, I cannot see how the court can relieve him of the rigour of his own contractual obligation. Any other approach means in effect that the court would simply be re-writing the contract for the parties - after the event, with the innocent party having no means of ascertaining what the new time limit might be until he comes to court and the court pronounced upon it. In Grandwide v. Bonaventure (supra), in a passage not cited by Liu J. in his judgment, Penlington JA said :

"Bonaventure do not dispute the general proposition that de minimis does not apply to time .....".

It is as well to recall the dictum of Lord Slamon in The Laconia [1977] AC 850 at 878 : "Certainty is of primary importance in all commercial transactions". This was cited in Lord Bridge's speech in The Chikuma [1981] 1 WLR 314 at 321G (one of the cases referred to us by counsel), and Lord Bridge then went on to say : "The ideal at which the courts should aim .... is to produce a result such that in a given situation both parties seeking legal advice as to their rights, and obligations can expect the same clear and confident answers from their advisers ...."

In the same vein Robert Goff LJ said in Scandinavia Trading v. Flota [1983] 1 QB 529 at 540E :

"It is of the utmost importance in commercial transactions that, if any particular event occurs which may affect the parties' respective rights under a commercial contract, they should know where they stand ....."."

24. For my part, I embrace the reasoning of Litton J.A. Where a bargain has been freely made, it is essential that parties should know exactly where they stand in the event of breach of an essential condition or stipulation. They should not be left in a limbo of uncertainty which will be resolved only after an expensive scrutiny of conduct, consequences and other matters thought material by a court. The Australian cases were, of course, not cited to the Court of Appeal. Compelling though the arguments are and attractive though the result might be in those cases, like Godfrey J., I see no reason to depart from the authority of the Privy Council contained in Steedman v. Drinkle (1916) AC 275.

25. In the circumstances, I reject the Defendant's submission on this issue.

Relief Against Forfeiture of the Deposit

26. The sub-agreement between the parties incorporates the conditions contained in part A of the Second Schedule of Cap. 219. Condition 10 reads :

"10. FAILURE OF THE PURCHASER

If the purchaser shall fail to comply with any of the terms and conditions of the agreement the deposit money shall be absolutely forfeited as and for liquidated damages (and not as a penalty) to the vendor who may (without being obliged to tender an assignment to the purchaser) rescind the agreement and either retain the property the subject of the agreement or any part or parts thereof or resell the same, either as a whole or in lots, and either by public auction or by private contract, or partly by the one and partly by the other, and subject to such conditions and stipulations as to title or otherwise as the vendor may think fit. Any deficiency arising from such resale and all expenses attending the same or any attempted resale shall be made good and paid by the purchaser as and for liquidated damages, and any increase in price realized by any such resale shall belong to the vendor. This clause shall not preclude or be deemed to preclude the vendor from taking other steps or remedies to enforce the vendor's rights under the agreement or otherwise. On the exercise of the vendor's right of rescission under the agreement the vendor shall have the right, if the agreement shall have been registered in the Land Registry, to register at the Land Registry an instrument to rescind the sale of the property. This clause shall not prevent the vendor recovering, in addition to liquidated damages, damages representing interest paid or lost by him by reason of the purchaser's failure."

27. With some force, Mr. Cheung submitted that this is a confusing condition. It purports to entitle a vendor to forfeit deposit money on the basis that it represents liquidated damages and is not a penalty. Therefore, it would appear to constitute a genuine pre-estimate of any loss likely to be incurred. The condition however, goes on to provide for the vendor to be able to recover in respect of items some of which at least would necessarily have been taken into account in trying to estimate any loss arising from the purchaser's failure to complete. The vendor, therefore, is both having its cake and eating it or put another way, the deposit represents a windfall for or unjust enrichment of the vendor.

28. `In his work on Penalties and Forfeiture, C.J. Rossiter discussed the nature of a deposit and some of the difficulties which arise in trying to ascertain on what basis relief against forfeiture should be granted. At page 108, he said :

"It is not in dispute that the deposit shares common characteristics with agreed damages. The deposit has a compensatory role. Upon termination of the contract for the purchaser's breach, the vendor is entitled to forfeit the deposit as compensation for the loss sustained. If the deposit serves as liquidated damages accruing to the vendor upon termination of the contract for the purchaser's breach, it would be consistent with principle to apply the penalty rules to strike down deposits excessive in amount. That is to say, a genuine or true deposit would have to be the product of a genuine pre-estimate of the likely loss arising from termination judged at the time of the making of the contract. There are cases supportive of this approach but there are many anomalies ....

The English Law Commission recognised this difficulty in its report on the law of penalty clauses : ("Penalty Clauses and Forfeiture of Monies Paid", Law of Contract Working Paper No. 61 (1975)).

"It will be seen that, like a penalty clause, a deposit can be regarded as operating in terrorem. Yet the courts do not seem to regard this as a reason why its forfeiture should not be upheld. Nor does the amount of the deposit necessarily bear any relation to the loss that a breach of contract might cause to the party not in breach: the ten per cent deposit on the sale of land is an arbitrary amount and can be retained by the vendor on the purchaser's breach even if he suffers no loss - indeed, even if he makes a profit on a resale and, because the market price of houses is rising, it was foreseeable when the original contract was made that he would do so. Since the forfeiture of a deposit does not prevent the vendor from suing for damages (giving credit for the amount forfeited) if he suffers further loss, he appears thus to get the best of both worlds. Yet, subject to equity's power to grant relief, to which we return below, it has been said that an order for the forfeiture of the deposit is 'one which is to be made ex debito justitiae ... I do not see how the court can hesitate for a moment in giving the plaintiff what he asks'" : John Barker & Co. Ltd. v. Littman [1941] Ch 405 at 412. (Ibid at para. 53)

The English Law Commission reasoned that the immunity from judicial review given to certain deposits was unjustified and ought to be changed. However, the Commission recognised the need for deposits paid in land contracts to be treated as exceptional. The prime reason for that was that to do otherwise would be to ignore custom and the expectation held by vendors and purchasers alike that deposits paid in land contracts were liable to forfeiture. However, the Commission thought that the usual 10 per cent deposit was unreasonable and excessive. It was thought that a deposit which was to be free from judicial review as a penalty should not exceed 5 per cent of the purchase price."

29. The confusion and difficulties have, I think, been laid to rest by the Privy Council in the recent decision Workers Trust and Merchant Bank Limited v. Dojap Investments Limited (1993) 2 WLR 702, where it had to grapple with forfeiture of a deposit of 25%. At page 705, Lord Browne-Wilkinson delivering the judgment of the Council said :

" In general, a contractual provision which requires one party in the event of his breach of the contract to pay or forfeit a sum of money to the other party is unlawful as being a penalty, unless such provision can be justified as being a payment of liquidated damages being a genuine pre-estimate of the loss which the innocent party will incur by reason of the breach. One exception to this general rule is the provision for the payment of a deposit by the purchaser on a contract for the sale of land. Ancient law has established that the forfeiture of such a deposit (customarily 10 per cent. of the contract price) does not fall within the general rule and can be validly forfeited even though the amount of the deposit bears no reference to the anticipated loss to the vendor flowing from the breach of contract ....

The history of the law of deposits can be traced to the Roman law of arra, and possibly further back still: see Howe v. Smith (1884) 27 Ch. D. 89, 101-102, per Fry L.J. Ever since the decision in Howe v. Smith, the nature of such a deposit has been settled in English law. Even in the absence of express contractual provision, it is an earnest for the performance of the contract: in the event of completion of the contract the deposit is applicable towards payment of the purchase price; in the event of the purchaser's failure to complete in accordance with the terms of the contract, the deposit is forfeit, equity having no power to relieve against such forfeiture.

However, the special treatment afforded to deposits is plainly capable of being abused if the parties to a contract, by attaching the label "deposit" to any penalty, could escape the general rule which renders penalties unenforceable. There are two authorities which indicate that this cannot be done. In Stockloser v. Johnson [1954] 1 Q.B. 476, Denning L.J. in considering the power of the court to relieve against forfeiture said, obiter, at p. 491 :

"Again, suppose that a vendor of property, in lieu of the usual 10 per cent. deposit, stipulates for an initial payment of 50 per cent. of the price as a deposit and part payment; and later, when the purchaser fails to complete, the vendor resells the property at a profit and in addition claims to forfeit the 50 per cent. deposit. Surely the court will relieve against the forfeiture. The vendor cannot forestall this equity by describing an extravagant sum as a deposit, any more than he can recover a penalty by calling it liquidated damages."

In Linggi Plantations Ltd. v. Jagatheesan [1972] 1 M.L.J. 89 Lord Hailsham of St. Marylebone L.C. delivered the judgment of the Board which upheld the claim to forfeit a normal 10 per cent. deposit even though the vendor had in fact suffered no loss. He referred on a number of occasions to a requirement that the amount of a deposit should be "reasonable" and said, at p. 94 :

"It is also no doubt possible that in a particular contract the parties may use language normally appropriate to deposits properly so-called even to forfeiture which turn out on investigation to be purely colourable and that in such a case the real nature of the transaction might turn out to be the imposition of a penalty, by purporting to render forfeit something which is in truth part payment. This no doubt explains why in some cases the irrecoverable nature of a deposit is qualified by the insertion of the adjective 'reasonable' before the noun. But the truth is that a reasonable deposit has always been regarded as a guarantee of performance as well as a payment on account, and its forfeiture has never been regarded as a penalty in English law or common English usage."

In the view of their Lordships these passages accurately reflect the law. It is not possible for the parties to attach the incidents of a deposit to the payment of a sum of money unless such sum is reasonable as earnest money. The question therefore is whether or not the deposit of 25 per cent. in this case was reasonable as being in line with the traditional concept of earnest money or was in truth a penalty intended to act in terrorem .....

In order to be reasonable a true deposit must be objectively operating as "earnest money" and not as a penalty ....

Since a true deposit may take effect as a penalty, albeit one permitted by law, it is hard to draw a line between a reasonable, permissible amount of penalty and an unreasonable, impermissible penalty. In their Lordships' view the correct approach is to start from the position that, without logic but by long continued usage both in the United Kingdom and formerly in Jamaica, the customary deposit has been 10 per cent. A vendor who seeks to obtain a larger amount by way of forfeitable deposit must show special circumstances which justify such a deposit."

30. It seems clear to me that Lord Browne-Wilkinson was drawing a distinction between a genuine deposit operating as earnest money for performance of the contract and a provision for the payment of liquidated damages representing a genuine pre-estimate of loss. Both can be impugned as penalties : the deposit because it is unreasonable and in truth intended to act in terrorem; the liquidated damages because they do not represent a genuine pre-estimate. In practice, there will no doubt be some overlaping and many of the matters to be taken into consideration in determining whether or not the parties have genuinely tried to pre-estimate the loss will be relevant to the reasonableness or otherwise of the deposit.

31. The Workers Trust case was the subject of analysis by Liu J. inSilver Pole Limited v. China Pride Investment Limited (1991 No. A 8894) in his judgment delivered on 18th February 1994. The judge was dealing with a deposit of 20%. His treatment of this topic was in fact obiter but he did say "there would seem to be little justification for granting a blank immunity to a 10% deposit but for its universal acceptance. It must, therefore, mean that the arbitrary 10% is itself, more often than not, exorbitant and that it is even more unjustified in a rising market. A deposit is after all, a guarantee that the purchaser means business or a guarantee for the performance of the contract."

32. It is to be noted that in Gladflow Limited. Godfrey J. was not prepared to treat a deposit of the conventional 10% as the exaction of a penalty. That decision was, however, before the decision in Workers Trust.

33. It was Mr. Cheung's submission that whether or not the deposit paid by the Defendant was reasonable can only be tested after an examination of all relevant factors, such as the particular social and economic conditions prevailing in Hong Kong, the effect of increasing property prices, the substantial profit that was apparently to be made by the Plaintiff over a short period of time, the impact of Condition 10, and evidence perhaps of conveyancing practice in Hong Kong. There may be some substance in that submission but, in my view, it is not necessary for me to decide upon it. In my judgment, the issue turns upon Condition 10 which was imported into and became a term of the sub-agreement. Effect must be given to that term. As I have already said, the condition seems to confuse a deposit and a provision for liquidated damages. Perhaps that confusion is understandable given the state of the authorities before Workers Trust. Whilst the two concepts have many similarities, they do in the final analysis involve separate considerations. A deposit must represent reasonable earnest money in all the circumstances. Liquidated damages must represent a genuine pre-estimate of loss. If either fails to pass the test, it will constitute a penalty which the courts may not enforce.

34. By Condition 10 the parties have, in my view, agreed to treat the deposit as a provision for liquidated damages. Or, at least, there has been an attempt, deprecated by Lord Browne-Wilkinson, to avoid problems which were apprehended might arise in relation to a mere deposit by "labelling" it as liquidated damages. That being so, the sum paid must represent a genuine pre-estimate of loss. There is understandably no evidence whatsoever on this point. The parties simply adopted the conventional 10% of the purchase price, neither they nor their legal advisors (again understandably) having given any thought to the distinction between a deposit and a provision for liquidated damages, and the need in the latter case to try and pre-estimate the loss consequent upon breach of contract.

35. Condition 10 constitutes a trap for the unwary. It should, as soon as possible, be amended so as to provide for the forfeiture of a genuine deposit and separately for liquidated damages. In the meantime, it seems to me to be necessary for conveyancers to avoid incorporating this condition inter any contract for the sale of land.

36. In the circumstances, I grant the first declaration sought by the Plaintiff that it was entitled to rescind the sub-agreement. I also make an order that the registration of the Action be vacated.

37. As to the deposit, it will now be for the Plaintiff, if it thinks fit, to try and justify it as representing a genuine pre-estimate of loss. I will hear counsel as to the appropriate directions to be given for the determination of this issue. I will also hear counsel on the question of costs.