What is the meaning of earnest money deposit in a contract for the sale of immovable property? What are the principles that govern the forfeiture of earnest money deposit? Under what circumstances can earnest money deposit be forfeited?

Question: What is the meaning of earnest money deposit in a contract for the sale of immovable property? What are the principles that govern the forfeiture of earnest money deposit? Under what circumstances can earnest money deposit be forfeited? Explain with some case laws. [DJS 2019]

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Answer

“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” Chiranjit Singh v. Har Swarup [AIR 1926 PC 1]

In Earl Jowitt, The Dictionary of English Law: Giving earnest or earnest money is a mode of signifying assent to a contract of sale or the like by giving to the vendor a nominal sum (e.g.a shilling) as a token that the parties are in earnest, have made up their minds.

The initial payment whether named as earnest or security deposit was intended as a cover or protection against inconvenience or possible loss likely to be caused by the breach. If the deposit was named as an earnest the court allowed it to be forfeited, but not otherwise, thus defeating the purport of the bargain that the parties had voluntarily made. The fact that the payment of a sum of money in a purchase agreement is not expressed as a deposit does not for that reason alone render the payment, not a true deposit or earnest money.

The intention of the parties with regard to the payment as earnest money may be gathered by examining the agreement as a whole. Even if no time for completion of the sale by paying the balance of the price was specified, the seller’s notice for completing the sale within seven days became a reasonable specification of time. Therefore, on the purchaser’s failure to do so, the money paid by him was validly forfeited even if there was no provision in the original agreement for any such forfeiture.

The rule of Section 74 of the Indian Contract Act is that where a sum is named in a contract as the amount to be paid in case of a breach, regardless of whether it is a penalty or not, the party suffering from a breach is entitled to receive reasonable compensation not exceeding the amount so named.

Principles that govern the forfeiture of earnest money deposit

1. No forfeiture where contract still not formulated
2. Earnest Money must be given “at the same time” when the contract is being concluded.
3. It should be a part of the total amount of purchase.
4. It must be given to make the contract binding, as a guarantee that the contract will be fulfilled.
5. No forfeiture where extra costs otherwise recovered
6. Neither earnest money nor another kind of deposit that is liable to be forfeited can be subjected to forfeiture if the underlying contract is void.
7. The forfeiture takes place only when there is a failure or fault on the purchaser’s part.
8. In case there is any default by the purchaser, the seller can forfeit the earnest money (but the terms of the contract should not show any contrary intention of the parties or terms or conditions specified).

Thus, it may be said that even when the court specifies the damages in cases of breach of contracts, by considering the intention of the parties while they were forming the contract and the money deposited in terms of ‘earnest’ or ‘deposit’, it is forfeitable.

In Commr of HR&CE Deptt v. S. Muthekrishnan, [AIR 2012 Mad 43] the requirement of tendering was satisfied by the highest bidder by depositing the requisite earnest money. The bid was not confirmed by the authority through a period of more than one year had passed. The bidder withdrew his tender. The authorities then confirmed his bid and forfeited his earnest money for not depositing the balance money within 30 days from the date of confirmation. The court said that the absence of any time prescribed for acceptance could not give the authority an unlimited and unreasonable period of time. The forfeiture was not proper and therefore the amount forfeited was refundable.

Circumstances in which earnest money deposit be forfeited

Forfeiture of earnest money only when reasonable to do so.—In the case of Shree Hanuman Cotton Mills v. Tata Aircraft Ltd [AIR1970SC1986], The plaintiffs contracted with the defendants to purchase from them zero scraps for rupees ten lakhs and paid Rs2,50,000/-, being 25 per cent of the purchase price. One of the conditions, among others being, that if he failed to pay the balance of the purchase price in accordance with the contract, the deposit would be forfeited and the contract cancelled.

The buyer defaulted and the seller forfeited the deposit. The buyer sued to recover it. The court held that the deposit in question was intended as earnest money. The agreement clearly provided that the deposit would carry no interest and would be adjusted in the final bills. It was a part of the price and the seller was entitled to forfeit it.

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Law of Contract Mains Questions Series: Important Questions for Judiciary, APO & University Exams

1. Law of Contract Mains Questions Series Part-I
2. Law of Contract Mains Questions Series Part-II
3. Law of Contract Mains Questions Series Part-III
4. Law of Contract Mains Questions Series Part-IV
5. Law of Contract Mains Questions Series Part-V
6. Law of Contract Mains Questions Series Part-VI
7. Law of Contract Mains Questions Series Part-VII
8. Law of Contract Mains Questions Series Part-VIII
9. Law of Contract Mains Questions Series Part-IX
10. Law of Contract Mains Questions Series Part-X