[4] Types of Deposits Differ; Unclear Terms Make Them Hard to Apply

Compiled from: Beijing No. 2 Intermediate People's Court
 
Case review
On March 7, 2022, Company B paid Company A 200,000 yuan as a deposit, and the parties did not agree on the type of deposit. On March 10, Company A (lessor) and Company B (lessee) formally entered into a Storefront Lease Contract, agreeing that Company A would lease the property in question to Company B at an annual rent of more than 770,000 yuan. The contract did not address the 200,000 yuan deposit already paid. Later, the property in question could not be used for some reason, and Company B filed a lawsuit, claiming that Company A’s breach of contract made it impossible to achieve the purpose of the contract, and demanding that Company A return double the deposit.

 
 

The court, after trial, held that Company B paid 200,000 yuan to Company A as a deposit on March 7, 2022. Although the parties did not agree on the type of deposit, judging from the time of payment of the deposit and the time of conclusion of the contract between the parties, Company B paid the deposit to secure the conclusion of the contract. After the parties had signed the Store Lease Contract on March 10, 2022, the security function of the deposit had been fulfilled. According to legal provisions, the deposit should be applied to the price or recovered, and no longer possessed the nature of a deposit. However, because the parties did not clearly agree that the deposit would be converted into a penalty deposit for breach, when one party breached its obligations under the Store Lease Contract, the other party’s request to apply the deposit penalty rule had no legal basis, and the court did not support it.
 
 
Civil Code of the People's Republic of China
Article 586
The parties may agree that one party pays a deposit to the other as a guarantee for the creditor's rights. The deposit contract is established upon the actual delivery of the deposit. The amount of the deposit is agreed upon by the parties, but it shall not exceed 20% of the principal contract's subject matter amount; any excess does not have the effect of a deposit. If the actual amount of the deposit delivered is more or less than the agreed amount, it is deemed a modification of the agreed deposit amount.
 
 
[1] The author's perspective
Clearly defining the type of deposit is crucial for accurately applying the deposit penalty rule, fully leveraging the role of deposits, and protecting legitimate rights and interests. When entering into a contract, parties should first understand the conceptual, nature, and functional differences between deposits and other payments to make reasonable choices and agreements. Deposits have a guarantee function and can be subject to the deposit penalty rule, while earnest money, security deposits, guarantee deposits, and advance payments generally do not apply to this rule. If the parties agree to use a deposit as a guarantee for debt, they should clarify the type of deposit as much as possible based on its purpose and effect. After the debtor performs the obligation, the parties should specify in the contract whether the deposit should be applied as payment, returned to the debtor, or continue to serve as a guarantee in the form of a deposit.