Reservation Agreement for the Purchase of Real Estate

Introduction

Anyone seriously interested in purchasing a parcel of land or a condominium unit is, in practice, often asked to sign a reservation agreement and to pay an initial deposit towards the purchase price or a reservation payment. The purpose of this arrangement is to reserve the property for the prospective purchaser until the actual sale and purchase agreement can be concluded. Such reservation agreements are regularly concluded in simple written form only, often for reasons of cost. If the principal contract is ultimately not concluded, the question arises whether the reservation agreement was validly concluded and what happens to any deposit already paid and to any contractual penalty that may have been agreed.

Formal Requirements

Contracts for the sale of real property require execution in the form of a public deed in order to be valid (Art. 216 para. 1 CO). The same applies to preliminary contracts by which a party undertakes to conclude such a sale agreement at a later stage (Arts. 22 para. 2 and 216 para. 2 CO). According to the case law of the Swiss Federal Supreme Court, a reservation agreement under which the purchaser undertakes to acquire the property and the seller undertakes to reserve it constitutes such a preliminary contract and is therefore likewise subject to the requirement of execution as a public deed (BGE 140 III 200). If the reservation agreement is concluded merely in writing, it is therefore null and void.

The formal requirement extends not only to the principal terms of the agreement but also to all objectively and subjectively essential contractual terms. According to the case law, this also includes contractual penalties connected with the preliminary contract, provided that they are intended to secure performance of the principal obligations under the preliminary contract.

Contractual Penalties in Reservation Agreements

Reservation agreements regularly contain a clause providing that, if the principal contract is not concluded, all or part of the deposit paid will remain with the seller. According to the case law of the Swiss Federal Supreme Court, such a contractual penalty is, in principle, subject to the formal requirement where it is intended to reinforce compliance with the pre-contractual obligations. By contrast, such a clause is valid without complying with the formal requirement if its sole purpose is to compensate the so-called negative contractual interest, that is, to place the party financially in the position it would have been in had it never relied on the conclusion of the contract (BGE 140 III 200).

This exception is interpreted narrowly. If the clause also provides compensation for lost rental income, for example, it is likewise subject to the formal requirement. According to more recent case law, it is not sufficient for the clause merely to be limited to compensation for the negative contractual interest. It must also specifically cover claims for damages arising from bad-faith conduct during the contractual negotiations (culpa in contrahendo) (Swiss Federal Supreme Court, 4A_109/2018). In practice, this requirement will rarely be satisfied, with the result that contractual penalties contained in reservation agreements will generally be regarded as invalid for failure to comply with the prescribed form.

Recovery of the Deposit

If the reservation agreement, together with the contractual penalty contained therein, is null and void, the purchaser may, in principle, reclaim the deposit under the rules governing unjust enrichment (Art. 62 para. 1 CO). The fact that the deposit was paid voluntarily and with knowledge of the formal defect does not preclude its recovery.

Abuse of Rights

The seller may not rely on the formal defect if doing so would violate the principle of good faith (Art. 2 para. 2 CC). According to the case law, reliance on the formal defect may, in particular, constitute an abuse of rights where the parties have voluntarily performed the formally invalid contract in full, or at least as regards its principal obligations, despite being aware of the formal defect. The mere payment of a deposit is not sufficient for this purpose (Swiss Federal Supreme Court, 4A_109/2018). Accordingly, a purchaser who seeks repayment of the deposit will generally not be considered to be acting abusively.

Conclusion

In practice, reservation agreements relating to the sale of real property are frequently concluded in simple written form only in order to avoid the costs associated with execution as a public deed. This, however, entails significant legal risks. As a general rule, both the reservation agreement itself and any contractual penalty contained therein are null and void for lack of execution as a public deed, and any deposit already paid may be reclaimed under the rules governing unjust enrichment. Anyone wishing to create a legally binding reservation agreement with financial consequences should therefore have the agreement executed in the form of a public deed.