Deposits and Break Fees in a Letter of Intent: When Money Changes Hands Before Closing

Most letters of intent for the purchase of a private business in Ontario do not involve a deposit at all. The letter is non-binding on the commercial terms, so a payment that would be forfeited for not closing sits awkwardly beside a clause saying nobody is obliged to close. Deposits become common at the purchase agreement stage, where the obligation to close exists and the deposit secures it.

A deposit at the letter stage is nevertheless requested in three situations. A seller in a strong position wants evidence that the buyer is serious before granting exclusivity. A seller agreeing to a long exclusivity period wants compensation if the buyer walks. Or the parties intend the letter itself to bind them on certain terms, and the deposit secures those. Each is legitimate, and each needs the letter to say precisely what the deposit is for and when it is returned.

The alternative to a deposit is a break fee: a promise to pay a stated amount if the deal fails for a stated reason. Break fees are more flexible, because they can be made payable by either party and triggered only by specific conduct. They are also harder to collect, because the money has not been paid yet. Many letters use both: a modest deposit in trust plus a break fee for defined breaches.

There is no standard amount. In private Ontario transactions a letter-stage deposit is usually a small percentage of the purchase price, enough to show commitment without putting a material sum at risk before due diligence. At the purchase agreement stage, deposits of up to ten percent are common; going higher increases the risk that a court will relieve the buyer from forfeiting it.

The deposit should be paid to a lawyer, usually the seller's lawyer, and held in the lawyer's trust account pending closing. Lawyers in Ontario hold trust funds under the Law Society's rules, and a lawyer holding a deposit releases it only on the terms on which it was paid into trust, the parties' joint direction or a court order. Paying a deposit directly to the seller is a mistake: if the deal fails and the seller refuses to return it, the buyer's only remedy is a lawsuit against a party that may have spent the money.

The letter should state whether the deposit earns interest and who receives it, whether it is credited to the purchase price at closing, which it almost always is, and the exact events on which it is returned to the buyer or released to the seller. "Returned if the transaction does not close" is not precise enough, because it does not say who gets the money when the buyer walks for a reason within its control.

The usual structure is that the deposit is fully refundable until the buyer's conditions are satisfied or waived, and non-refundable after. Until the end of due diligence the buyer can terminate for any reason or no reason and recover the deposit. Once the buyer confirms it is satisfied, waives its financing condition and commits to close, the deposit is at risk: if the buyer then fails to close for a reason other than the seller's default, the seller keeps it.

Three refinements are worth negotiating.

Partial forfeiture. A buyer who terminates late in due diligence for a reason unrelated to the business, for example because its financing fell through, may agree that a portion of the deposit is forfeited to compensate the seller for lost time. This gives the seller something for a long exclusivity period without making the full deposit non-refundable before the buyer has finished its work.

Seller default. The deposit must be returned in full if the seller fails to close, breaches the letter's binding terms or cannot deliver clean title to the shares or assets. The letter should say so expressly, and should say that the return of the deposit does not limit the buyer's other remedies.

Dispute mechanics. If the parties disagree about who is entitled to the deposit, the lawyer holding it will keep it until they agree or a court decides. A short clause requiring joint written instructions, and allowing the lawyer to pay the money into court if none arrive within a stated time, prevents a trust account from becoming a hostage.

A true deposit is forfeited when the buyer defaults, and the seller does not have to prove it suffered a loss. The Court of Appeal for Ontario confirmed the principle in Benedetto v. 2453912 Ontario Inc., where a purchaser signed an agreement to buy real property "in trust for a company to be incorporated without any personal liabilities", paid a $100,000 deposit and refused to close. Under section 21 of Ontario's Business Corporations Act a person who signs in that way is not personally bound by the contract if the contract says so, and the court accepted that the purchaser was not liable on the agreement. It held that the deposit was forfeited anyway, because a deposit is a separate promise, an earnest to bind the bargain, and is lost on the payer's non-completion unless the contract expressly provides otherwise; this one said nothing about returning the deposit.

Two cautions follow. First, call the payment a deposit and say it is forfeited on default; a payment described as a "part payment" or an "advance" may be recoverable even after a default. Second, the forfeiture rule has limits. Under section 98 of the Courts of Justice Act a court can relieve against forfeiture where the deposit is out of all proportion to the seller's actual loss and it would be unconscionable for the seller to keep it. The Court of Appeal has said relief is exceptional, and a deposit in the customary range is rarely disturbed, but there is no fixed percentage: the court looks at the full commercial context, including the parties' conduct.

Break fees are judged on a related test. A fee that is a genuine pre-estimate of the loss the innocent party would suffer will generally be enforced as liquidated damages, and the Court of Appeal has said courts should prefer to ask whether enforcing an agreed remedy would be unconscionable rather than strike it down as a penalty. A fee whose purpose is to punish the other side for walking away risks being treated as a penalty, which an Ontario court may refuse to enforce. Keep the fee tied to the costs actually at stake, such as the buyer's documented diligence and legal spend up to a cap, and state the commercial reason for it in the clause.

When a deposit is paid at the letter stage, the clause should answer each of the following, in the binding part of the letter:

• Amount and timing. The sum, the date it is due, and that it is paid by wire to the named lawyer's trust account.
• Status. That it is a deposit, paid as security for the buyer's performance, and not a part payment, an advance or an option fee.
• Interest. Whether it is invested, and if so who receives the interest, which is usually the party that ends up with the deposit.
• Credit at closing. That it is applied to the purchase price on closing.
• Return. The events on which it is returned in full: termination by the buyer before the end of the diligence period, failure of a condition that is not within the buyer's control, the seller's default, or expiry of the outside date without closing for reasons not attributable to the buyer.
• Forfeiture. The events on which the seller keeps it: the buyer's failure to close after waiving its conditions, or the buyer's breach of a binding term of the letter.
• Partial forfeiture, if negotiated, with the amount and the trigger.
• Release mechanics. That the lawyer releases the deposit on joint written instructions, and may pay it into court if the parties have not agreed within a stated period after a demand.
• Relationship to damages. Whether forfeiture is the seller's sole remedy for the buyer's failure to close, which buyers prefer, or is without prejudice to a claim for further loss, which sellers prefer.

A clause that covers these points leaves little for a court to decide. One that says only "the buyer will pay a deposit of $50,000, refundable if the deal does not proceed" leaves everything.

A reverse break fee runs the other way: the buyer pays the seller if the deal fails because of something on the buyer's side, typically a failure to obtain financing or a regulatory approval the buyer was responsible for. Sellers who grant long exclusivity to a buyer with uncommitted financing should ask for one. The amount is usually calibrated to the seller's cost of the lost period: professional fees, management time and the discount the seller may face on re-marketing a business that is known to have been under contract.

Cost reimbursement is the modest version of a break fee. The seller agrees to reimburse the buyer's documented third-party costs, up to a cap, if the seller breaches exclusivity or sells to another buyer within a period after the letter ends. Buyers who have been burned by a seller shopping their offer often make this the one binding economic term they insist on. Our guide to exclusivity and no-shop clauses explains how the two provisions fit together.

Whatever the structure, the money terms in a letter of intent are binding terms, and they can make a letter that was meant to be non-binding look like a contract. Wallace v. Allen is the warning: a letter that reads like a completed bargain, backed by conduct consistent with a done deal, may be one. Draft the deposit and fee clauses as free-standing binding provisions, keep the statement that the commercial terms are non-binding, and have the letter reviewed before any money moves. If you are being asked for a deposit at the letter stage, talk to us first.