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Deposit Bonds DOES THE PURCHASER NEED TO PROVE IF THE RESCISSION OF THE CONTRACT OF SALE IS LEGITIMATE? By Maria Kyriacou | July 2006

The use of deposit bonds in property transactions is a common practice in Australia. If settlement of a property is effected, the deposit bond can benefit both the purchaser and vendor. It provides the purchaser with flexibility by acting as a ‘substitute’ for a cash deposit. The vendor receives the benefit of an undertaking (normally guaranteed by an insurance company) upon which the vendor can call if the purchaser defaults in performance of the contract. In return, the deposit bond issuer receives a fee from the purchaser, who promises to indemnify the deposit bond issuer (by way of a counter indemnity) from any losses incurred in paying out on the bond. The relationship between all parties is shown below:

Purchaser

Agrees to issue deposit bond in return for a fee (usually through an agent)

Deposit Bond Issuer

Enters into contract of sale & gives deposit bond in lieu of cash deposit

Promises to pay back amount of deposit bond payment made

Administers and procures deposit bond business in return for a fee

Vendor

Undertakes to pay deposit if Purchaser doesn’t complete

Deposit Bond Guarantor

What rights does the deposit bond issuer have against a purchaser claiming a legitimate right to terminate the underlying contract of sale? In the recent case of Lumley General Insurance Limited v Hogan,1 the County Court of Victoria held that the deposit bond issuer must pay a demand without inquiry into the validity of the termination by either the purchaser or vendor.

Facts In early 2002, Mr Hogan entered into four contracts of sale to acquire four apartments in a proposed development in Melbourne. In lieu of a cash deposit, the Vendor accepted four deposit bonds which Mr Hogan obtained from Shield Underwriting Agencies (Shield) acting as agent for the bond underwriter, Lumley General Insurance Limited (Lumley). Some time prior to settlement, Mr Hogan sought to rescind the contracts.2 However, the Vendor refused Mr Hogan’s rescission, asserting that his grounds for rescission were spurious. Unremarkably, Mr Hogan refused to complete settlement of the apartments.

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The Vendor subsequently rescinded the contracts and demanded payment from Lumley. After meeting the Vendor’s demands, Lumley demanded payment from Mr Hogan. It relied on the clause in the deposit bond contract by which Mr Hogan agreed to: “unconditionally and irrevocably indemnify Lumley against all actions, claims, demands, liabilities, losses, damages, costs and expenses... which Lumley at any time suffers...directly or indirectly... in connection with the deposit bond and... upon demand... pay Lumley any amount so indemnified.” When Mr Hogan failed to make payment, Lumley, as principal, issued proceedings in the County Court of Victoria for recovery of the debt.

The Dispute Mr Hogan defended Lumley’s action on three grounds. He maintained that: 1. 2. 3.

as he had validly terminated the contracts, Lumley had no right to seek repayment from him; his termination of the contracts ended the validity of the deposit bonds by the bonds’ own terms; and as the Vendor’s rescission of the contracts was invalid, it had no grounds to call on the deposit bonds.

Findings Ostrowski J dismissed Mr Hogan’s claims, citing Meriton Apartments Pty Ltd v GNC Access Pty Ltd3 with approval. His Honour found that the deposit bond agreement did not oblige Lumley to inquire as to the validity of rescission. That was a fact that Mr Hogan had to prove either by a court determination or by obtaining a concession from the Vendor. Ostrowski J said:4 “The role of the deposit bond in the context of the present case is clear enough: it takes the place of cash which, but for the bond, the purchaser...would have had to pay and of which the vendor, subject to the terms of the Contract of Sale, would have had the benefit. As the bond replaces cash, it needs to be “as good as cash”: Wood Hall Ltd v Pipeline Authority (1979) 141 CLR 443 at 457, per Stephen J.” His Honour was critical of Mr Hogan’s failure to establish the validity of his rescission. He said to force the Court to make such an inquiry would be “both unnecessary and improper”5 given the Vendor was not a party to the proceeding. His Honour reasoned his findings by stating that arguments about the operation of the contracts of sale were irrelevant to the relationship between the purchaser and the deposit bond issuer. There was no duty on the deposit bond issuer to establish whether the Vendor was entitled to make the demand. Each of Mr Hogan’s arguments failed. Lumley had legitimately paid out under the bonds and was entitled to obtain repayment of the deposit bond amounts from Mr Hogan, in addition to interest and indemnity costs.

Implications This case illustrates that a purchaser cannot defeat the legitimate claim of a deposit bond issuer by asserting an unproven repudiation of the underlying contract of sale. Unless the purchaser joins the vendor in the action, or obtains a concession from the vendor, the court will not force the deposit bond issuer to inquire as to the rights or authority of the Vendor to call upon the bond.

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This decision will give comfort to deposit bond issuers and vendors alike, who can be assured that the courts will give force to the commercial purpose of the deposit bond. In light of this case, and other authority on point,6 there appears to be increasing judicial endorsement of the view that the bond ought to be “as good as cash”. A copy of the judgment can be found at: http://www.countycourt.vic.gov.au/CA256D90000479B3/Lookup/Judgments_L/$file/VCC0245.pdf

End Notes Unreported, County Court of Victoria, Ostrowski J, 20 February 2006. TurksLegal acted for the deposit bond issuer. 2 In Victoria, a vendor must provide what is known as a “Vendor s 32 Statement” to the purchaser prior to entering into a contract of sale under s 32 of the Sale of Land Act 1962 (Vic). In this case, the contracts erroneously stated the properties were subject to a mortgage. Mr Hogan used that fact to support his claim that the parties had contracted on the basis that vendor arranged finance would be available. The Vendor’s s 32 Statements did not provide details of the alleged vendor arranged finance. Mr Hogan claimed that the Vendor breached s 32 of the said Act and sought to exercise his right of rescission pursuant to s 32(5) of that Act. The Vendor claimed that the parties had in fact contracted on the basis that clear title would pass at settlement. 3 (2003) 1 DCLR (NSW) 207 4 Unreported, County Court of Victoria, Ostrowski J, 20 February 2006 at para 18. 5 Above n 4 at para 41. 6 Meriton Apartments Pty Ltd v GNC Access Pty Ltd (2003) 1 DCLR (NSW) 207. 1

For More Information Please Contact Maria Kyriacou Lawyer T: 03 8600 5003 maria.kyriacou@turkslegal.com.au

Melbourne | Level 10 (North Tower) 459 Collins Street , Melbourne, VIC 3000 | T: 03 8600 5000 | F: 03 8600 5099 Sydney | Level 29, Angel Place, 123 Pitt Street, Sydney, NSW 2000 | T: 02 8257 5700 | F: 02 9239 0922

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Deposit Bonds  

The use of deposit bonds in property transactions is a common practice in Australia. If settlement of a property is effected, the deposit bo...