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How to deal with vendor negative equity and the risk to purchasers’ deposits

2 Feb 2023

| Author: Joanna Pidgeon

For some years the property market has been rising and the issue of vendor negative equity has not been a key concern. But with property prices falling and some vendors having purchased at the peak of the market, the sale price after paying the real estate agent’s commission may be less than the debt on the property. A conscientious vendor in this situation would make the contract conditional upon obtaining mortgagee approval to the sale. Some vendors however are not so conscientious.

The rules 

Deposits are typically 10% of the purchase price and are usually paid to the real estate agent. Under clause 2.4 of the ADLS/REINZ 11th Edition 2022(2) Agreement, the deposit is to be held by the recipient as stakeholder until:

  • the requisition procedure under clause 6 is completed without cancellation;
  • any conditions are fulfilled or waived;
  • pre-settlement and additional disclosure is completed for unit title properties;
  • the agreement is cancelled pursuant to clause 6.2(3)(c) (requisition clause) or avoided pursuant to clause 9.10(5) (return of deposit for cancellation due to non-fulfilment of condition or waiver of nonfulfilment); and
  • s 151(2) of the Unit Titles Act 2010 for unit title properties has been completed and the agreement has been cancelled by the purchaser or the purchaser has elected not to cancel by notice or has completed settlement of the purchase.

Pursuant to s 123(1) of the Real Estate Agents Act 2008 (REA), when the deposit is received by a real estate agent it is to be held by the agent for 10 working days from the date of receipt unless under s 123(2) of the REA the court orders or the parties agree for the deposit to be released early. This stems from a purchaser’s ability to requisition the title within 10 working days of the agreement signed under clause 6.2 of the agreement.

Purchasers are often chased to authorise the release of the deposit early to enable a vendor to use the net deposit balance to pay the deposit on their subsequent purchase. Section 123(3) of the REA requires agents to continue to hold the deposit if they receive written notice from a party to the transaction of any requisitions or objections in respect of the title to any land affected by the transaction. The deposit may not be released except in accordance with a court order or an authority signed by all the parties to the transaction.

Losing the deposit 

There has been a disturbing trend in some agreements with additional clauses inserted mandating agreement for the immediate release of the deposit on payment in some “unconditional” agreements and particularly in some auction agreements.

Agents are keen to receive their commission and vendors want their deposits to be released so they may use the net balance to fund the deposit on their next purchase. While the deposit is usually released on an agreement becoming unconditional, if the vendor does not fulfil its obligations on settlement – such as being able to convey title with a discharge of mortgage – the purchaser on cancellation of the agreement is entitled to a full refund of the deposit.

However, if the agent has taken their commission from the deposit and the balance released to a possibly insolvent vendor and the vendor is unable to discharge their mortgage, the purchaser is faced with issuing court action for the return of the full deposit. This may be fruitless if the vendor is in a negative equity situation. If the vendor is pushed to bankruptcy, the mortgagee as a secured party on the land will receive the net sale proceeds of the property, with the real estate agent having no obligation to disgorge their commission.

With high levels of borrowing at increasing interest rates and property prices falling, there have been more situations where purchasers have lost their deposit as the deposit has been released, the agent has taken their commission and the vendor the balance, but the vendor has been unable to transfer title to the purchaser due to negative equity and the purchaser has lost their deposit.

Rethinking the risk 

Should there be a rethink of risk under sale and purchase agreements? And should the deposit be held by the agent/vendor’s solicitor in trust pending the vendor being able to transfer clear title? As set out above in the agreement, the deposit is held by the stakeholder until the agreement is unconditional or cancelled, right to requisition has passed and disclosure obligations have been complied with for unit title properties. If the sale is off the plan, agreements usually provide for the deposit to be held in the lawyer’s trust account as stakeholder pending issue of title, practical completion and the issue of the code compliance certificate, but sometimes until settlement. This would protect purchasers until settlement. However, sales and purchases are often in a chain and vendors often want to use the balance of deposit to help fund their deposit on a purchase.

Protecting the purchaser 

What should a purchaser’s lawyer do when considering the vulnerability of the purchaser’s deposit? The purchaser should consider requiring the deposit to be held by a stakeholder until settlement in these situations: if the vendor is in financial difficulty; where a vendor is not yet the owner of the land; and if the vendor is building on the land.

However, purchasers’ lawyers don’t always have the opportunity to advise on conditions. If you are asked to authorise the early release of the deposit, get instructions from your client and explain the risk if the vendor can’t transfer title on settlement. Under clause 3.8(2) of the agreement, the purchaser has the right to the transfer of title.

Requisition of title is different from matters going to the process of conveying title to the purchaser. A mortgage is not a defect in title subject to requisition under clause 6 of the agreement. The purchaser may raise matters of conveyance up until the settlement date, and the vendor must comply or be in breach.

If you are acting for a purchaser and have a concern as to whether the vendor can convey clear title on settlement, you should consider raising an issue or objection as to conveyance (this is not a requisition as to title under clause 4) and ask for evidence as to the vendor’s ability to convey title on settlement.

The vendor’s lawyer should be able to satisfy this objection by providing bank evidence as to the amount required to be repaid on settlement and demonstrating that there will be sufficient funds to repay. If this is not forthcoming, a purchaser’s lawyer might consider raising an objection with the real estate agent under s 123(3) of the REA so the deposit is held until settlement. ■

Joanna Pidgeon is a director of Pidgeon Judd and convenor of the ADLS Documents and Precedents Committee ■

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