The Pros and Cons of Liquidated Damage
The Pros and Cons of Liquidated Damages in a Real Estate Transaction
The Residential Purchase Agreement (“Contract”) you are about to execute contains a “Liquidated Damages” provision. This provision, if initialed by the parties, is an agreement that in the event of a breach of contract by the buyer the amount of damages the seller will be entitled to receive will be limited to the amount of the buyer’s deposit. It is important to note that there may be advantages and disadvantages for the parties to a Contract if they elect liquidated damages. It is, therefore, STRONGLY RECOMMENDED THAT YOU SEEK LEGAL COUNSEL’S ADVICE if you have any questions on this subject matter.
In an effort to assist clients and customers of Coldwell Banker in understanding liquidated damages, the following information is being provided. This information is not intended, however, to provide legal advice and/or in any way make an affirmative recommendation with regards to the subject matter. Clients and customers are recommended to obtain legal advice regarding this subject from their legal counsel. The following is a brief list of some, but not all, of the advantages and/or disadvantages, which may be associated with liquidated damages.
ADVANTAGES TO LIQUIDATED DAMAGES – If initialed, liquidated damages establishes an agreed upon amount of damages in the event the buyer breaches the Contract. This amount can be any agreed upon amount, but to be presumed valid, it may not exceed 3% of the purchase price for a transaction, which involves residential property, one to four units, one of which the buyer plans to occupy. In the event of a breach by the buyer, the seller does not have to prove that he/she has been damaged, only that a breach has occurred.
Not all cancellations are a breach of contract. For example, if the buyer is unable to obtain financing and notifies the seller during the financing contingency period in the Contract, the buyer’s cancellation is not a breach of contract. Therefore, the seller would not be entitled recover damages, either liquidated (if the provision is initialed) or actual (if the provision is not initialed).
DISADVANTAGES TO LIQUIDATED DAMAGES – In the event a seller has been damaged for an amount greater than the agreed upon liquidated damages amount, the seller’s recovery is limited only to the liquidated amount. An agreement to liquidated damages does not mean that the parties will avoid litigation. If the seller believes that the buyer has breached the Contract the seller will not receive the deposits held in escrow automatically, nor if the buyer believes that they have not breached the Contract will the buyer automatically receive the deposit back. The issue of whether the buyer has breached must still be agreed to between the parties or by a trier of-fact and law. This process could include Mediation, or Arbitration (if the provision is applicable) or litigation through a court of law. In most cases the escrow holder will hold the funds deposited in escrow until such time as the parties agree to distribution or a trier-of-fact and law orders the release of funds to either party.
However, all parties are obligated to sign an instruction to the escrow holder covering how the deposit is to be distributed if there is a good-faith resolution of the dispute on the deposit issue. Refusal to sign a release instruction, if required, could be followed by mediation, arbitration (if initialed), or litigation in court. If the seller is found to have had no good-faith claim for withholding the deposit, the seller may be ordered to pay, in addition to the withheld deposited funds, the prevailing party’s attorney’s fees and costs in addition to a penalty for refusing to release the deposit when no good-faith dispute exists.
Under California Law, Liquidated Damages is only agreed upon when all parties to the Contract have initialed the appropriate provision. In addition, only the initial deposit is covered by the Liquidated Damages provision in the Contract. If additional deposits are to be covered by the provision, an additional document (Receipt for Increase Deposit/Liquidated Damages CAR form RID) must be executed by all parties, otherwise additional or increased deposits are not in most cases considered liquidated damages and cannot be claimed by the seller as such.
IMPORTANT NOTE – The Liquidated Damages Provision must be initialed by all parties to the Contract for the provision to become a part of the agreement.