Navigating aborted commercial contracts: when is an advance payment refundable?

With a recession looming and many businesses attempting to negotiate the market turbulence resulting from supply chain issues and sudden currency and interest rate changes, commercial disputes regarding deposits are growing more common. The most popular queries relate to refunds in the event of an abortive transaction.

As there is no legal requirement for a buyer to put down an advance payment for goods or services, there must be a specific clause in the contract. The first port of call is to consider the terms of the contract and ascertain the purpose of the advance payment, which can either be categorised as a deposit or as a part-payment. The distinction between the two types of advance payment is particularly important, as it has a direct bearing on whether the matter is refundable or not.

What is a deposit and how does it differ from a part-payment?

Both types of advance payment have the effect of reducing the amount that must be paid when the goods or services are delivered. A buyer will often pay a deposit to secure a price, whereas a part-payment is exactly that: payment of part of the price. However there is a subtle but important legal difference between a deposit and a part-payment.

A deposit can be characterised as both security for the performance of a contract, and as part-payment of the purchase price. Both elements must be present in order for it to be construed as a deposit. Where a contract provides for the payment of a deposit, the general rule is that it is taken to belong to a supplier or seller, if the party paying the deposit defaults in the performance of the contract (Howe v Smith (1884) 27 Ch D 89). However a part-payment may be returnable in the event of breach by the buyer. In F&T Terrix Ltd v CBT Global Ltd [2021] EWHC 3379 (Comm), it was held that a buyer is not entitled to the repayment of a deposit, as it is only repayable where it is solely the fault of the seller that the contract does not complete.

By comparison, a part-payment is not a guarantee of the seller’s performance, therefore legally it is different to that of a deposit. If a buyer fails to perform the contract or cancels, the buyer can claim a refund of any part-payments. However buyers should also be mindful that they themselves would be liable to a supplier in damages for their breach of contract. For suppliers, this means that a right to retain a part-payment is not automatic, and they would need to prove their losses in order to retain that payment.

When might a part-payment or deposit be refundable?

There are however a number of important factors as to whether a supplier is entitled to keep an advance payment or not.

It is not uncommon for part-payments to be subject to express written terms in the event of a breach. For example, a supplier may stipulate that where a buyer breaches terms of exclusivity and/or confidentiality, the advance payment is forfeited.

A part-payment may also be refundable if certain scenarios occur. For example, in Nord Naphtha Ltd v New Stream Trading AG [2021] EWCA Civ 1829, the Court of Appeal held that under the terms of a contract the buyer was entitled to be repaid an advance payment in the event of force majeure: an unforeseeable act, event or circumstance beyond the control of the parties. In that case, there was a single reference in the contract’s force majeure clause, which stated that only a force majeure event would obligate the supplier to repay the advance payment to the buyer.

The size of a deposit can also have a bearing on whether it is refundable or not. The deposit amount is a point of negotiation between the parties. That said, if the deposit is significantly high compared to the total purchase price, then it could be held as a penalty, and therefore unenforceable. Were it to be deemed a penalty, the buyer could have grounds to demand its return. Each case is fact sensitive and the circumstances of a transaction must be taken as a whole when looking at the size of the deposit.

If a contract expressly describes an advance payment as a ‘deposit’, but is silent as to whether it is refundable or not, then it will generally be classed as a deposit. The payment will therefore not be refundable.

If the contract does not describe the advance payment as a deposit and there is no basis to believe that the payment is conditional on the buyer’s performance, then it will be classed as a part-payment. The payment is therefore refundable, subject to any losses the supplier may be able to claim if the buyer has cancelled in breach of the contract.

If there is no written contract, then it is important to examine what was said and done, in order to ascertain whether the parties intended that the advance payment would be a deposit or not.

Practical tips

Before entering into a contract it is important to:

1. ensure that any advance payments are clearly stated as being deposits or part-payments;
2. consider including an express right to a refund of any advance payment (particularly for buyers) in the event of a breach;
3. consider how the payment obligations sit alongside any force majeure clauses; and
4. consider the size of the deposit being taken and whether it could amount to a penalty.

For plain-speaking, comprehensive advice or to discuss a dispute, please get in touch with our Commercial Litigation team.

This reflects the law at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought as appropriate in relation to a particular matter.