I agree Alison, totally wrong to withhold the deposit, however, the wording on the deposit receipt needs to be read very carefully here too, if there is but a receipt and no 'small print' she is fully entitled to have the money returned as the breeder has changed her mind, not the potential owner.........but, remember there are always two sides.

The breeder may well have asked if there were any ailments with the other dogs, if it were known before the deposit, with no disclosure then she may well be entitled to do this, or the potential puppy owner may well have indicated that having a pup now is not the right time too, or asked the breeder to hold onto the pup for longer whilst tests are done? Leaving the breeder doubtful of full intentions towards the pup. It really does depend on the conversations they have had prior.
However, if it is as cloak and dagger as it sounds, the pup was still wanted, with no impact to its welfare, it is completely wrong and she needs to seek a solicitor and trading standards, especially if it was a large deposit.
I just have the feeling that it is not quite as simple and straight forward as the potential owner is making out, I really don't like to think breeders can and would be this cruel.
If I were this person, I would ask the breeder to put in writing her reasons for holding onto a deposit in this way, and then a decision can be made as to whether it was within her rights or if it needs legal dealings, but it needs to be in writing so that there are no misunderstandings or hearsay.