Putting a Forfeiture Clause in an Agreement to Sell: Pros and Cons

An agreement to sell is a common instrument used in property transactions in India. It records the intention of the buyer and seller to complete a future sale on agreed terms, usually after payment of earnest money or advance consideration. One clause that frequently appears in such agreements is the forfeiture clause, which allows the seller to retain the advance amount if the buyer fails to perform the contract.

While forfeiture clauses are widely used, their legal effect is often misunderstood. Many parties assume that the mere presence of a forfeiture clause automatically entitles the seller to keep the entire advance amount in case of default. In reality, Indian courts apply strict legal principles to determine whether forfeiture is lawful.

This article explains the meaning, legal position, advantages, disadvantages, and judicial approach to forfeiture clauses in agreements to sell.

What Is a Forfeiture Clause?

A forfeiture clause is a contractual term stating that if the buyer fails to complete the transaction within the stipulated time or breaches the agreement, the seller is entitled to forfeit (retain) the earnest money or advance paid.

A typical forfeiture clause may state that:

• The advance amount shall stand forfeited if the buyer defaults, or

• The seller may cancel the agreement and retain the earnest money without further liability.

Such clauses are intended to act as a deterrent against breach and to compensate the seller for loss of time and opportunity.

Legal Framework Governing Forfeiture Clauses

In India, forfeiture clauses are primarily examined under:

• The Indian Contract Act, 1872, particularly provisions relating to compensation for breach of contract.

• Judicial precedents laid down by the Supreme Court and High Courts.

Courts distinguish between:

• Earnest money, which may be forfeited in certain circumstances, and

• Advance or part payment, which generally cannot be forfeited unless actual loss is proved.

The law does not permit unjust enrichment. Even where a forfeiture clause exists, courts assess whether forfeiture is reasonable and legally justified.

Pros of Including a Forfeiture Clause

1. Acts as a Deterrent Against Buyer Default

A forfeiture clause discourages casual or speculative buyers from backing out without valid reasons. It ensures that only serious buyers enter into agreements.

2. Compensates the Seller for Delay and Uncertainty

Property transactions often involve opportunity costs. If a buyer defaults, the seller may have lost time, alternative buyers, and market value. A forfeiture clause offers partial compensation for such inconvenience.

3. Reduces Frivolous Litigation

Where terms are clear and reasonable, a forfeiture clause can reduce disputes regarding cancellation of agreements and refund of advance amounts.

4. Provides Contractual Certainty

Including a forfeiture clause clarifies the consequences of breach, reducing ambiguity in contractual obligations.

Cons and Legal Risks of a Forfeiture Clause

1. Not Automatically Enforceable

A forfeiture clause does not guarantee that the seller can retain the entire amount. Courts scrutinise:

• The nature of the payment

• The amount forfeited

• Whether actual loss is proved

Excessive or arbitrary forfeiture is often disallowed.

2. Distinction Between Earnest Money and Advance

If the amount paid is substantial and resembles part payment of sale consideration rather than earnest money, courts may order refund, even if a forfeiture clause exists.

3. Requirement to Prove Loss

In many cases, sellers are required to show that they suffered actual loss due to the buyer’s breach. Mere inclusion of a forfeiture clause is not enough.

4. Risk of Litigation

Improperly drafted forfeiture clauses often lead to litigation. Buyers may challenge forfeiture as unfair, excessive, or illegal, especially when market conditions have changed.

5. Seller’s Default Nullifies Forfeiture

If the seller is unable or unwilling to perform their obligations (such as clearing title defects or executing the sale deed), forfeiture cannot be enforced against the buyer.

Judicial Approach to Forfeiture Clauses

Indian courts have consistently held that:

• Reasonableness is the key test

• Forfeiture must not amount to a penalty

• Large sums cannot be forfeited mechanically

Courts examine:

• Conduct of both parties

• Whether time was of the essence

• Whether the seller resold the property without loss

• Whether the buyer was genuinely at fault

Where no loss is proved, courts often direct refund of advance money, sometimes with interest.

Practical Tips While Drafting a Forfeiture Clause

1. Clearly define whether the amount paid is earnest money or advance consideration.

2. Keep the forfeitable amount reasonable and proportionate.

3. Specify timelines clearly and state whether time is the essence of the contract.

4. Avoid blanket forfeiture of large sums.

5. Ensure seller’s obligations are clearly recorded to avoid allegations of default.

A carefully drafted clause reduces disputes and increases enforceability.

Conclusion

A forfeiture clause in an agreement to sell can be a useful contractual safeguard, but it is not absolute. Indian law balances contractual freedom with fairness and reasonableness. While forfeiture clauses can protect sellers against unjustified buyer defaults, they also carry legal risks if drafted or invoked improperly.

Both buyers and sellers should understand that forfeiture depends not only on contractual wording but also on facts, conduct, and actual loss. Proper legal drafting and clarity at the agreement stage can prevent costly disputes later.

Disclaimer

This article is for general legal awareness and informational purposes only. It does not constitute legal advice. The applicability of law depends on specific facts and circumstances. Readers are advised to seek professional legal consultation before acting on any legal issue.