COVID-19: What About Customer Deposits?
by Frederick Welk
CEDF Business Advisor
I've been talking calls from business owners worried about conflicts with customers over deposits for services they have ordered but now either don't want or the business is unable to provide. This is assuredly a time of high tension as businesses of all kinds try to protect their cash. Setting aside the philosophical discussion of how a generous refund policy can aid a business' reputation in the long run in normal times, it's important to understand what legal obligations might be in play now. Of course, every situation and contract is different, but I reached out to David Dobin, principal with Cohen & Wolf, PC for some general guidance for small business owners.
CEDF: I can imagine an argument that deposits are held as security until the services are provided and the customer meets any of its own obligations. On the other hand, some might argue a deposit is earned immediately because it represents compensation for the potential opportunity cost of setting aside resources.
David Dobin: You are correct that every situation and contract is different and - especially under these emergency conditions - businesses should speak with an attorney to answer specific questions. Even under normal circumstances, disputes over whether a business is permitted to keep a customer’s deposit are common.
The first step in resolving a dispute over a deposit is to review the terms of the applicable contract. The contract may provide that the deposit is fully refundable, only refundable under certain conditions, or not refundable; or the contract may say nothing at all. Even if the contract allows a business to keep a deposit, however, state and federal statutes and other principles of Connecticut law may forbid it. For instance, the Connecticut landlord-tenant statutes set forth specific rules on when, how much and under what circumstances a security deposit may be kept. Also, while Connecticut law permits valid “liquidated damages” clauses, it prohibits imposition of a penalty for breach of contract as a violation of public policy. In fact, improperly keeping a deposit paid by a consumer may subject a business to liability under the Connecticut Unfair Trade Practices Act (CUTPA), and CUTPA requires every consumer to sign a statement in bold immediately following a liquidated damages provision which reads, “I ACKNOWLEDGE THAT THIS CONTRACT CONTAINS A LIQUIDATED DAMAGES PROVISION.” See Conn. Gen. Stat. § 42-150u.
A contract permitting a business to keep a deposit will violate public policy if the amount of the deposit is greatly disproportionate to the amount of the damage which would be sustained in the event of a breach of the contract. Therefore, in determining whether a refund request must be honored, each business should consult with an attorney to consider its unique circumstances, including whether the customer is a consumer, when and why the refund is demanded, the expenses the business has already incurred, and the ability of the business to mitigate its damages by, for example, finding another customer.
CEDF: What does the Uniform Commercial Code or Connecticut law have to say about when a deposit is earned by the company in a business agreement? Is the situation only controlled by the language of the agreement or are there overriding obligations? Seems like a good time to remember that important and owner-composed agreements would benefit from legal review.
DD: Article 2 of the Uniform Commercial Code (codified at Title 42a of the Connecticut General Statutes) governs contracts relating to the sale of goods. Oftentimes contracts will involve both the sale of goods and services, or the sale of goods to consumers, and other principles of law may apply. As a result, the contract and all of the surrounding circumstances should be reviewed with an attorney to determine the rights to deposited funds.
Under section 2-717 of Connecticut’s UCC, a contract allowing the business to retain a deposit must be “reasonable in the light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy.” In addition, section 2-615 excuses a seller from timely delivery if it has been made impracticable by an unforeseen occurrence or by a requirement to comply with applicable law. These statutory provisions are consistent with other legal doctrines – described in response to the previous question – prohibiting contractual penalties and excusing parties from fully performing in the event of unforeseeable events.
As a result of the COVID-19 pandemic, the Governor of Connecticut has issued a number of emergency orders including rules that close businesses, prohibit people from congregating and suspend court and other legal deadlines. These orders may make it impossible or impracticable for both businesses and customers to fulfill their obligations under a contract – giving both sides an argument that they are entitled to the deposit. Businesses are therefore encouraged to try to amicably resolve disputes caused by a government-ordered shutdown by coming up with creative alternate solutions so that the parties can both get the benefit of the original contract. In doing so, businesses should reach out to their attorneys to better understand their contracts and potential liability when dealing with deposit disputes and, for the future, review their contracts to ensure they include language favorably allocating the risks of such unforeseeable events.
CEDF: What about businesses like caterers that customarily use deposit money to buy the food in advance that must be prepared for an event? Does this intention have to be spelled out in the contract?
DD: It is always recommended that the contract clearly describe the circumstances in which the deposit is refundable, make clear that the parties intend that the deposit reasonably approximates the business’s damages in the event of a breach, and what the deposit is going to be used for (such as food expenses). The agreement should also include the date after which it is too late to demand a full refund because of expenses that the business is expected to incur. For instance, if a refund is demanded at such a late time that a caterer has already incurred expenses to buy food and other items in advance, and those can’t be used for other events, then the law against “penalties” may not require a total refund of the deposit.
The current emergency circumstances, however, require other legal principles to be considered. Many contracts have “force majeure” clauses. These contractual provisions prohibit contracting parties from requiring each other to perform in the event of unforeseen and unexpected situations like hurricanes, tornados and natural disasters. In those situations, neither party has a right to insist on performance and the contract may be refundable no matter what the other provisions of the contract say. Even without a “force majeure” provision, other legal doctrines forgive a breach of contract if it is objectively impossible to do so or the purpose of the contract is frustrated. Although these doctrines are more difficult to prove, they may affect the ultimate question of whether a deposit can be kept or should be returned. For this reason, a business faced with these difficult questions should speak with an attorney.
CEDF: So, as difficult as this might be for small businesses, isn't the best practice to consider deposits as a liability because it might have to be returned, rather than co-mingle it with normal business working capital and spend it before the services are delivered?
DD: In light of the law against unenforceable penalties in contracts and legal principles that excuse performance when doing so would be impossible or impracticable, businesses should be mindful that not all deposits are non-refundable (even when the contracts appear to make them so). Their finances, including how and when deposited funds are spent, should therefore be adjusted accordingly. For specific questions on how to account for deposited funds, businesses should contact their accountants.
David Dobin is a principal of Cohen and Wolf, P.C. and represents individuals, businesses and condominium associations in a variety of litigation matters, including debt collection actions, trademark disputes, foreclosure defense and prosecution, contract disputes, business tort claims, breach of fiduciary duty claims, mechanic’s lien foreclosures, eviction actions, premises liability matters and other various complex commercial litigation matters.
The information provided above does not, and is not intended to, constitute legal advice. Readers of this article should contact their attorney to obtain advice with respect to any particular legal matter.