Learning Outcomes
After reading this article, you will be able to explain the legal purpose and effect of the exchange of contracts in freehold real estate transactions. You will distinguish stakeholder and agent deposit arrangements, identify when a contract becomes binding, advise on buyer and seller remedies for breach or delay, and apply these rules confidently to SQE2-style scenarios, including practical examples.
SQE2 Syllabus
For SQE2, you are required to understand the legal significance and mechanics of exchanging contracts in the sale of freehold property. You should focus your revision on the following points:
- The function and formalities of exchange of contracts in freehold conveyancing
- When and how a contract becomes legally binding for buyer and seller
- Stakeholder and agent treatment of deposits: practical and legal differences
- Remedies for delay, breach, or non-completion after exchange, including deposit forfeiture
- Practical steps and recognised methods of exchange (in person, post, telephone, Law Society formulas)
- Common pitfalls, including the risks of reduced deposits and agency arrangements
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- At what precise moment does a contract for the sale of a freehold property become legally binding?
- Why is it usually safer for a buyer if the deposit paid on exchange is held as stakeholder rather than as agent?
- What main remedies are available to a seller if the buyer fails to complete after exchange of contracts?
- What risks apply if a reduced deposit is paid or if the deposit is released to the seller before completion?
Introduction
Exchange of contracts is the central event in freehold property conveyancing. It marks the point at which a transaction moves from non-binding negotiations to a contract that binds both seller and buyer to complete on agreed terms. Understanding exactly when the contract becomes binding, how deposits are managed, and what happens if plans change or either side defaults, is essential for effectively advising clients and addressing practical SQE2 assessments.
Key Term: exchange of contracts
The formal process in a property sale where counterparts are exchanged, creating a binding contract upon both seller and buyer.
The Significance of Exchange
Before exchange, either party can withdraw at will (unless a specific penalty or contract says otherwise). At the moment of exchange, both parties become legally committed to complete on the agreed date and under the agreed terms. The transaction is no longer "subject to contract."
Requirements for a Valid Contract
For a freehold sale contract to become binding at exchange, the contract must:
- Be in writing,
- Include all agreed terms,
- Be signed by each party or on their behalf,
- Be physically or formally exchanged (i.e., each party holds a counterpart signed by the other, or the agreed process is otherwise completed).
From this point, the parties are legally obliged to complete the transaction, pay/receive the deposit, and face consequences if there is delay or failure to complete.
Key Term: completion
The moment when legal title passes from seller to buyer, keys are released, and the balance of the purchase price is paid on the agreed completion date.
Methods of Exchange
Contracts can be exchanged by various methods:
- In person: The solicitors physically meet and hand over signed contract parts.
- By post: Exchange happens when one party posts the signed part to the other, if agreed.
- By telephone using Law Society formulae: Each solicitor holds a counterpart and exchange occurs via a recorded/confirmed telephone agreement.
Once exchange is completed by any recognised method, the transaction becomes binding at law.
Binding Effect and Consequences
At exchange, the buyer typically pays a deposit (commonly 10% of the purchase price). After exchange, neither party can withdraw without penalty. Completion date is fixed, and default by either side can have serious financial implications.
Deposit Arrangements
Deposit Payment on Exchange
The deposit, nearly always paid by the buyer on exchange, serves two functions: it signals commitment and acts as security for any default.
Key Term: stakeholder
A neutral party (commonly the seller’s solicitor) holds the deposit after exchange, only releasing it to the seller on completion. If the sale fails to complete, the stakeholder ensures the correct refund/payment depending on who is at fault.Key Term: agent (for the seller)
A party (again, often the seller’s solicitor, but here acting expressly as agent) holds the deposit and may release it to the seller before completion, increasing risk for the buyer.
If the deposit is held as stakeholder, it cannot be released to the seller except upon completion (or clear buyer fault after failure to complete). If it is held as agent, the seller may receive the funds before completion, and the buyer risks not recovering the deposit if the seller becomes insolvent or disappears.
Reduced Deposit and Top-up Provisions
By agreement, a seller may accept a reduced deposit (e.g., 5%). If so, a wise seller will negotiate a "top-up" clause so that if the buyer defaults, the seller can claim the full 10% deposit (or whatever the standard is) from the buyer. Failure to include such a provision leaves the seller more exposed.
Remedies After Exchange
If the buyer fails to complete, the seller normally may:
- Serve a notice to complete
- Forfeit the deposit (often after notice and a short grace period)
- Rescind the contract and sue for damages (difference in selling price, costs/losses)
If the seller fails to complete, the buyer may:
- Recover the deposit with interest
- Sue for specific performance or damages
Buyers defaulting after exchange risk losing the deposit and possibly being liable for damages beyond the deposit. Sellers who default may face claims for the buyer’s wasted costs and in some cases, the buyer forcing completion (specific performance).
Worked Example 1.1
Scenario: The parties to a freehold property sale exchange contracts by telephone using Law Society Formula B. The buyer has not yet received clear confirmation of mortgage approval.
Question: After exchange, can the buyer withdraw without penalty if mortgage funds are refused?
Answer:
No. Once valid exchange has occurred, the buyer is bound to complete. If the buyer cannot, the deposit may be forfeit and further damages could be claimed by the seller, depending on losses caused.
Worked Example 1.2
Scenario: The buyer pays a 10% deposit on exchange, but the contract states the seller’s solicitor holds the deposit as agent for the seller. The seller soon spends the deposit. Before completion, the sale falls through, with the seller at fault.
Question: Is the buyer's deposit protected?
Answer:
No. Because the deposit was released to the seller before completion (agent arrangement), the buyer’s chances of recovering the deposit if the seller is insolvent are much reduced. If the deposit had been held as stakeholder, the stakeholder would have been obligated to return it.
Exam Warning
For SQE2, ensure you distinguish between stakeholder and agency deposits. If the exam scenario (or real-life client) wants maximum security for the deposit, recommend stakeholder status.
Revision Tip
Do not allow clients to exchange contracts until all financing and satisfactory due diligence are complete. After exchange, withdrawal is legally difficult and costly.
Summary
- Exchange of contracts creates a legally enforceable agreement tying both parties to complete on the agreed terms.
- The buyer pays the deposit at exchange. Stakeholder arrangements give greater protection to the buyer.
- Completion is fixed for a set date after exchange; failure to complete exposes party at fault to financial and legal penalties.
- Reduced deposits put the seller at increased risk; “top-up” clauses or higher deposits are preferable when possible.
Key Point Checklist
This article has covered the following key knowledge points:
- Exchange of contracts marks the point where a freehold property sale becomes binding; withdrawal after exchange can lead to severe financial penalties.
- A buyer’s deposit is safest held by a stakeholder, not as agent for the seller.
- The party at fault for failure to complete faces loss of the deposit (buyer) or claim for damages (seller).
- Parties should not exchange before arranging funds, due diligence, and satisfactory conditions.
- Sellers who accept a reduced deposit should negotiate “top-up” clauses to protect against further buyer default.
Key Terms and Concepts
- exchange of contracts
- completion
- stakeholder
- agent (for the seller)