A recent Ontario Court of Appeal case addressed the legal question of how the law governing deposits that secure contracts for the purchase and sale of real property interacts with the law that governs pre-incorporation contracts.
(Pre-incorporation contracts are similarly regulated in Alberta under s. 15 of the Alberta Business Corporations Act.)
In 2017, the buyer, an individual, entered into an agreement of purchase and sale with the vendor, a corporation. The buyer signed the agreement, stipulating that he was signing as a buyer “in trust for a company to be incorporated without any personal liabilities”. The agreement was for the purchase of three adjacent houses in Toronto at a price of $7 million. The buyer paid deposits totalling $100,000 under the agreement.
Subsequently, the buyer advised the vendor that he would not be closing the transaction, and he sought the return of the deposit. The vendor refused. The buyer brought an action and the vendor brought a motion for summary judgment.
The motion judge held that the provisions of the Ontario Business Corporations Act (“OBCA”) addressing pre-incorporation contracts did not displace the common law rules governing deposits in real estate transactions, and found that the deposit was forfeited to the vendor.
The buyer appealed on the basis that the motion judge erred in his interpretation of s. 21(4) of the OBCA and in his interpretation of the contract.
Position of the Parties
The buyer relied on s. 21(4) of the OBCA. Subsections 21(1) and (4) state:
21 (1) Except as provided in this section, a person who enters into an oral or written contract in the name of or on behalf of a corporation before it comes into existence is personally bound by the contract and is entitled to the benefits thereof.
(4) If expressly so provided in the oral or written contract referred to in subsection (1), a person who purported to act in the name of or on behalf of the corporation before it came into existence is not in any event bound by the contract or entitled to the benefits thereof.
The buyer submitted that because he complied with 21(4) and entered into the agreement on behalf of a company to be incorporated without personal liability, the deposit and accrued interest should be returned to him despite his failure to close the transaction.
The vendor relied on settled law that a purchaser’s failure to close a real estate transaction results in the forfeiture of a deposit, unless the contrary is expressly stated in the agreement of purchase and sale. The vendor submitted that a deposit is not a pre-incorporation contract which is subject to the exclusion of personal liability under s. 21(4), but instead an earnest to secure performance which is forfeited if the purchaser does not close the agreement of purchase and sale.
The court began by stating that where a buyer gives a vendor a deposit to secure the performance of a contract for purchase and sale of real estate, the deposit is forfeited if the purchaser refuses to close the transaction, unless the parties bargained to the contrary.
Regarding the OBCA, the court explained that s. 21 modifies the common law of contract by clarifying the rights and obligations parties assume in pre-incorporation contracts. Pre-incorporation contracts are contracts executed by a person acting as a promoter or functionary – that is, executed on behalf of a company intended to be incorporated at a later date. Section 21(1) established the personal liability of the promoter, unless liability is contracted out under s. 21(4). The court explained:
“The default rule of personal liability is thus subject to an opt-out under s. 21(4), where the parties make it clear that is what they have chosen.”
Therefore, in the event of a breach of a pre-incorporation contract where s. 21(4) applies, the vendor has no remedy for the breach. As a result, the vendor cannot obtain damages against the intended corporation because the intended corporation, if it even came into existence, did not adopt the contract.
With regard to the application of the OBCA to the deposit, the court found that the motion judge made no error in his decision. The court agreed that the buyer’s obligations under a contract of purchase and sale were distinct from the obligation incurred by the payer of the deposit. An implied term of a deposit is that on breach of the contract by the purchaser (or, in the case of a pre-incorporation contract, by the promoter on behalf of the intended purchaser), the deposit is forfeited to the vendor.
The court found that it was reasonable for the motion judge to interpret the phrase “without any personal liabilities”, in the context of the contract as a whole, as not applying to the deposit. The court agreed that the buyer’s argument would render a deposit meaningless, providing no incentive to close the transaction, and no compensation to the vendor for failure to close.
As a result, the court dismissed the appeal and the vendor was allowed to keep the deposit.
There are significant legal and financial risks in entering into a residential real estate transaction. Such large purchases should not be made without proper guidance from an experienced lawyer. Without sound legal advice, you could end up paying more than you should for your home, or accept an offer that is too low, or worse yet, end up with a transaction that falls through due to missed paperwork, or details and technicalities that go unnoticed.
At DBH Law in Calgary, our real estate lawyers have more than 25 years of combined experience acting for purchasers, lenders, and developers through all stages of residential real estate transactions.
We help our clients avoid huge areas of risk, including poorly drafted or incomplete agreements of purchase and sale, hidden fees, encroachment or easement issues, complex concerns like properties held in trust, and similar pitfalls. We also look for contract language which may impose unfavourable duties or obligations. To learn more about how we can help, contact us online or by phone at 403.252.9937.