What Exactly are Liquidated Damages and Should I Agree?
Updated: Oct 25, 2019
Making an offer for a new home is an exciting moment. When writing the offer the main focus is typically the price, and then maybe contingencies if any.
But what about the other 15+ pages of the contract? What is the real world impact of all those other places you have to initial, or choose not to? People rarely anticipate problems, or even their own emotional reactions in a real estate transaction, so they often don't spend enough time thinking about many of the other important choices they have to make in the purchase contract.
What Are Liquidated Damages?
One of those choices is liquidated damages. This clause allows buyers and sellers to agree, in advance, to a cap on the amount of money (damages) the sellers might recover if the buyers don't close the transaction in violation of the contract. This is generally limited to the amount put down as a deposit, or 3% of the purchase price, whichever is lower. In fact California Civil Code § 1675(c) expressly limits liquidated damages to 3% for residential real estate.
In order to have liquidated damages as part of the agreement both buyers and sellers must initial this clause. If either party doesn't initial, there is no pre established agreement on this issue. In fact, if there is no mutual agreement on liquidated damages one way or the other, there is no valid contract at all.
Does this Protect the Buyer or Seller?
The major benefit to the liquidated damages clause is that everybody knows what the payment might be if the buyer breaches the contract and fails to purchase the property. Without it the seller could sue for actual financial loss due to the buyers' breach of contract. This creates uncertainty as to how much damages might be, and potentially subjects everyone to a lengthy, messy court proceeding. Once in the courts there are no guarantees what the award will be, if any. So in a very real sense, it protects all parties involved.
That being said the liquidated damages clause only defines the remedy if the buyer breaches the contract. If the seller breaches, the buyer may have to sue for actual damages (or specific performance, which is another post altogether.)
If I Don't Close Do I Automatically Lose My Deposit?
Not necessarily. There are contractually valid reasons for a buyer to back out of a purchase, such as their good faith inability to release one or more contingencies. In these cases any deposit money should be returned in full. The liquidated damages clause only addresses situations where a buyer does not complete the purchase for reasons not agreed to in the purchase contract.
It's important to note that even if everybody agreed to liquidated damages, and the buyers breach the purchase contract, the money isn't automatically dispersed. The escrow holder will only release the deposit money with written instructions signed by both buyers and sellers, or a decision by a judge or arbitrator.
Buyers and sellers should carefully consider if liquidated damages is in their best interest. You can discuss it with your real estate professionals but they cannot provide legal advice. If there are questions you should always consult a qualified California real estate attorney.