Deposit Bonds Warning - Compliance of Terms and Conditions is Essential

A vendor under a contract for the sale of land may, by prior agreement, accept from a purchaser a deposit bond as payment of the deposit due on exchange of contracts rather than the usual method of payment by cheque or cash.

A deposit bond is a guarantee by a third party (usually a financial institution) to pay to the vendor on demand the guaranteed amount (the deposit) subject to the vendor’s satisfaction of the terms and conditions of the bond.

The recent New South Wales Supreme Court case of Reliance Developments (NSW) Pty Limited v Lumley General Insurance Limited [2008] illustrates the importance of complying with the specified terms and conditions of the deposit bond to ensure the vendor receives the guaranteed amount on demand (or at all!).

The Facts

The purchaser entered into a contract for the sale of land (the Contract) with the vendor and, by agreement between the parties, paid to the vendor the deposit of $160,000 in the form of a deposit bond (the Bond) on exchange of contracts. The Bond was issued by Lumley General Insurance Limited (Lumley) on 22 June 2006 with an expiry date of 22 September 2006.

Completion of the Contract was scheduled for 25 July 2006. When the purchaser did not complete on this date the vendor delivered to the purchaser a notice to complete dated 3 August 2006 and then, following the purchaser’s failure to complete, a notice of termination of contract dated 12 September 2006.

Under the terms and conditions of the Bond, the vendor was entitled to receive the amount of $160,000 for validly terminating the Contract provided that Lumley received from the vendor a written notice of demand for the guaranteed amount, a copy of the notice of termination served by the vendor on the purchaser, a statement by the vendor that the vendor had not been paid the deposit by the purchaser in accordance with the Contract, and the original Bond.  The address specified on the Bond for the service of these documents was a post box at Hurstville.

On 15 September 2006, the vendor’s solicitors faxed to Lumley a notice of demand, a statement that the deposit had not been paid in accordance with the Contract, a copy of the Bond, and inadvertently, a copy of a notice of termination of a lease by the vendor rather than the required notice of termination served by the vendor on the purchaser under the Contract. No action was taken by Lumley upon receipt of these faxed documents.

During the period of the Bond, Lumley’s mail was being re-directed from its Hurstville post box to its new office at North Sydney and the originals of the faxed documents, including the incorrect notice of termination of a lease, sent by the vendor’s solicitors were received by Lumley on 21 September 2006.  

On the day these original documents were received (including the original Bond), Lumley sent a letter to the vendor’s solicitor advising them that the wrong notice of termination had been received. The vendor’s solicitor received this letter from Lumley on 25 September 2006, three days after the expiry of the Bond, and then sent the correct notice of termination which was received by Lumley on 27 September 2006. Lumley refused to pay the $160,000 to the vendor on the basis that the Bond had expired.

The Decision

Justice Bryson concluded that the “language of the Bond” indicated that strict compliance of its terms and conditions was required in order for the amount guaranteed by the Bond to be paid to the vendor. Sending copies of the documents by fax did not comply with the terms of the Bond and Lumley was under no obligation to action the demand by the vendor until it received the original documents. Furthermore, Lumley was not obligated to notify the vendor’s solicitor of the inclusion of the incorrect notice of termination upon receipt of the faxed documents as the vendor and Lumley had a commercial relationship only and thus one party was not the custodian of the other party’s interests. Justice Bryson pointed out that “strictness with respect to the conditions is a long established aspect of the approach of the court to guarantees”. Consequently, the judgment was in favour of Lumley and the vendor did not receive the $160,000.

The Advice

A cash deposit is always preferable, however, the commercial reality is that often a bond is the only means by which the purchaser can provide the deposit to the vendor on exchange of contracts. If a vendor agrees to accept a deposit bond in lieu of cash, it is advisable to pay particular attention to:

  1. Period of the Bond. The bond should commence as close as possible to exchange of contracts and have a period of indemnity of at least three months (assuming a standard 42 day settlement) to account for possible delays in completion of the contract.
  2. Pre-approval. A vendor should have its solicitor review the form of the deposit bond prior to exchange of contracts. The terms of the bond should not be more onerous than the vendor’s rights to the deposit under the contract.
  3. Conditions of the Bond. The vendor’s solicitor must be familiar with the terms and conditions of the deposit bond and ensure they are followed exactly and before the expiry date of the bond so that payment of the guaranteed amount is not refused.
  4. Method of Service. Personal delivery is recommended where possible, when the receipt of original documents is crucial to the fulfilment of conditions of a contract. If the vendor’s solicitor had been able to personally deliver the documents to Lumley on 15 September 2006, they would have still had in their possession the original Bond when Lumley advised them of their error regarding the notice of termination of lease. The vendor’s solicitor would then have been able to re-serve to Lumley all the original documents including the correct notice of termination before the expiry of the Bond.


Rosemary Tedesco, Solicitor, wrote this article.