Singapore’s stable economy and political climate have made it an attractive destination for investors looking to diversify their portfolios. With the instinctive flight to quality, the real estate market has witnessed significant growth and is considered one of the most sought after in the region.
However, purchasing real estate in the current economic climate is not without potential pitfalls. Investors must be ever vigilant when it comes to reviewing penalty clauses in any kind of commercial contract.
In commercial contracts, parties may agree that, upon breach, the defaulting party is obliged to pay the innocent party a specified sum. Nevertheless, the rule against penalties (i.e. the penalty rule) serves to protect the weaker contracting party from oppression by its stronger counterpart. In this regard, the Courts have long differentiated between a specified sum which represents a genuine pre-estimate of loss (which is enforceable) from a sum which is out of proportion to any damages liable to be suffered and serves only to penalise (which would bean unenforceable penalty clause).
A related question arose in the context of a real estate contract in the recent Singapore High Court case of TG Master Pte Ltd v Tung Kee Development (Singapore) Pte Ltd1. The court considered whether an investor would be entitled to a refund of monies paid pursuant to an Option to Purchase (“OTP“) when the monies were forfeited from his failure to exercise the OTP within the exercise period. The details of the case are set out in the following paragraphs.
TG Master Pte Ltd v Tung Kee Development (Singapore) Pte Ltd
An investor (the “Investor“) was interested in buying eight units in a new condominium development. The condominium developer (the “Developer“) had therefore issued the Investor eight separate OTPs with option periods of two years each, in consideration for the investor paying option fees roughly equivalent to 2% of the sale price of each unit.
The Developer intended to allow the Investor to occupy and/or sublease the 8 units prior to purchase. The terms of the eight OTPs therefore required the Investor to make a further payment of S$500,000 towards each unit (equivalent to roughly 18% of the sale price of each unit) (hereinafter, “Further Sums“) within four months of the OTPs being issued to the Investor, upon which the Developer would enter into a tenancy agreement with the Investor for the units.
Most crucially, the 8 OTPs all separately contained bundling provisions which required the Investor to make payment of the Further Sums for all of the 8 units, before any of the OTPs could be separately exercised by the Investor. In other words, considering the option fees and Further Sums for all 8 OTPs, the Investor was obligated to pay 160% of a single unit’s sale price before he was even able to exercise any of the OTPs for the units. At trial, the Developer explained that the bundling provisions were included to account for the bulk discount that the Developer had given for anticipated bulk purchase of 8 units by the Investor.
After the Investor paid the Further Sums, he ultimately decided not to exercise any of the OTPs. This resulted in the Developer forfeiting the Further Sums for all OTPs.
Notwithstanding the fact that the OTPs contained express terms that allowed the Developer to forfeit the Further Sums paid by the Investor in the event that the Investor did not exercise the OTPs, the Investor was ultimately successful in his counter-claim against the Developer for the full refund of the Further Sums.
The two issues before the Court in deciding whether a refund was warranted were:
- Were the Further Sums a deposit or part-payment;
- If they were part-payment, whether the Developer’s right to forfeit the same a penalty.
Deposit vs Part-Payment
As the OTPs gave the Developer the right to forfeit the Further Sums, the Court first had to determine whether the Further Sums paid by the Investor were a deposit or part-payment. This was crucial as a deposit could be validly forfeited (i.e. not subject to the penalty rule), while part-payment could only be forfeited if it did not offend the penalty rule.
Under the law, a deposit must be reasonable as earnest money i.e. that it is meant to indicate a purchaser’s interest and good faith in a transaction. In determining reasonableness, the Court will have regard to the customary amount that is usually collected in a specific context. In this particular case, the Court noted that a 10% deposit was customary in the context of contracts for the sale of land and/or immoveable property.
As the Further Sums (equivalent to roughly 18%) far exceeded this customary amount, the Developer bore the burden of showing “special circumstances” to justify this higher amount. Although the Developer alluded to the relatively long option period that was granted in this case (i.e. 2 years), the Court disagreed that the longer option period in itself qualified as such special circumstances. The Court therefore held that the Further Sums were to be characterised as a part-payment instead.
Whether forfeiture of the Further Sums contravened the penalty rule
Having found that the Further Sums were collected by the Developer as part-payment, the Court then went on to examine whether the forfeiture of the Further Sums was a penalty. In essence, a forfeiture of a sum paid would be deemed a penalty if it was imposed by Party A to penalise or punish Party B for breach or non-performance of the contract, as opposed to being a genuine pre-estimate of Party A’s loss resulting from Party B’s breach or non-performance.
In this case, the Court found that the forfeiture of the Further Sums infringed the penalty rule. In particular, the Court held that the fact that the Investor was required under the terms of the OTPs to pay the Further Sums to the Developer for all 8 units in order to exercise the OTPs for any of the units was clearly penal in nature, as it was imposed to compel the Investor to pay the Further Sums so that he could deal with each of the Properties individually. The Court also found that there was no proper reason why the Developer would require retention of the Further Sums to account for any loss it may suffer.
The Developer was therefore ordered to return the full Further Sums amount (amounting to S$4 million) to the Investor.
Concluding remarks
This case illustrates that it may be worth consulting a lawyer to see if certain clauses in your real estate contracts are enforceable, even if after you have already entered into the contract and have paid sums pursuant to it. In particular, purchasers or investors need not necessarily let the threat of the forfeiture of paid sums deter them from pulling out of an investment.
Footnote
1 – [2022] SGHC 316
