According to the lawyer as the vendor believes that the buyer has not "acted in good faith," the letter from the bank stating that finance has been rejected does not terminate the contract. Therefore the contract between the buyer and the vendor is still in place and so the deposit does not have to be returned.

Just to keep you all updated, my friend has just returned from seeing a lawyer and as it turns out the issue is not over missing the 4pm deadline but rather that the vendor feels that my friend did not act in good faith when seeking financial approval for the purchase of the property. Basically the vendor believes that my my friend did not try hard enough to get finance, despite trying her bank and a mortgage broker.
According to the contract the offer does not go unconditional after the 4pm deadline but continues until either party terminates it, which is what my friend did by submitting a letter from the bank stating that her finance had been rejected. So now legal proceedings have to begin with the worst case senario being that my friend could be up for a minimum of $10,000 of legal fees for herself, another $10,000 of legal fees for the vendor as well as any pecieved financial losses the vendor might have realised as a result of my friends finance being rejected (i.e value of house dropping whilst waiting for finance to be approved and missing out on other possible buyers).
All pretty scary stuff and certainly a valuable lesson to anyone putting an offer in on a property without being certain they can get financial approval.

Thanks for the detailed response Linar. So just to clarify, even though the vendor was notified before the deadline that finance was not approved, because the official letter from the bank was not recieved before the 4pm deadline the contract has been breached the deposit does not have to be returned.

Yeah, I really feel bad for her, not a great situation to be in. My friend did not have a conveyancing solicitor involved, everything was done through the estate agent. The agent did call my friend at 4.15pm on the day of the deadline to let her know that she had to provide them with a letter stating that she had been refused finance otherwise she would not get her deposit back, however at this point in time the deadline had already passed.

I thought that if you sold your primary place of residence you didn’t have to pay CGT. I could be wrong though.