The Application of the Penalty Rule for Deposit

Both parties agreed in the purchase contract that if the seller delays the delivery for more than 15 days, the deposit amount to RMB100,000 shall be refunded, and the seller shall also undertake the default fine amount to 20% of the total price. Later then, the seller failed to deliver on time, the buyer filed a lawsuit to the court, and required the seller to refund doubled amount of the deposit, in addition with the default fine.

Whether the court would support the buyer’s claim? This question brings out 2 sub-questions. Whether both parties could agree to rule out the penalty rule for deposit? Whether the penalty rule for deposit and default fine could be applied together?

Firstly, the penalty rule for deposit could be ruled out by both parties. Article 120 of “Interpretation of the Supreme People’s Court on the Application of Certain Issues Concerning the Guarantee Law” states that if the purpose of the contract can not be realized due to the delay of one party in performance or other breach of the contract, the penalty rule for deposit shall be applied except it is otherwise stipulated by law or by agreement of the parties. However, the agreement on ruling out the penalty rule for deposit should be clear and direct, otherwise, such agreement might not be supported. For example, in the case (2015) Yi Zhong Min (Shang) Zhong No. 5651, the court points out that the contract stats that after the buyer has paid the deposit, if the buyer breaches the contract, then the seller could keep the deposit, but the contract did not stipulate that if the seller has breached the contract, then the seller does not have to refund doubled amount of the deposit. In view of this, the court determined that both parties had not ruled out the penalty rule for deposit, and finally ordered the seller to refund doubled amount of the deposit. Therefore, if both parties would like to rule out the penalty rule for deposit, it is recommended to stipulate very clear in the contract, for example, if the party who received the deposit has breached the contract, this party does not have to refunded doubled amount of the deposit, or the party shall only have to refund 100% of the deposit.

Secondly, the penalty rule for deposit and the default fine could not be applied together. Article 116 of “Contract Law” prescribes that if the parties agree on both default fine and a deposit, and one party is in breach,the other party may choose to apply either the provisions for the default fine or that for the deposit. Therefore, in judicial practice, the general opinion of the court is while the provision for the deposit is applied, the observant party may require the defaulting party to double refund the deposit; or while the provision for the default fine is applied, the defaulting party shall refund the deposit and undertake the relevant default fine. If the default fine is too high, the defaulting party could request the judicial departments to adjust. However, if the double deposit could no make up for the loss, the observant party could request the judicial departments to adjust the amount in accordance with Article 114 of “Contract Law”. For example, Shanghai No. 2 Intermediate People’s Court has made a decision in support of the double deposit and an additional compensation in the case of (2014) Hu Er Zhong Min Yi (Min) Zhong No. 1117.

In summary, as regards the application of the penalty rule for deposit, there are many specific laws and regulations. When you plan to stipulate a deposit provision, it is recommended to stipulate the refund rule and the default fine clearly and directly.