Q: As a Buyer, if I cancel a real estate transaction after releasing my contingencies, does the Seller keep my deposit?
A: This question is one that even many real estate agents mistakenly believe they know the answer to. In fairness, the standard real estate contracts are to blame – if you read the contract exclusively, it would appear very clear cut – that the answer to this question is “Yes.” However, those contracts are not the whole story…
When you are buying a home (for purposes of this article, we are focusing on transactions for primary residences only, excluding new construction condo projects), your contract will usually provide for an earnest money deposit of 3%. This is the amount deposited to open escrow, regardless of the full down payment. There will be a separate provision regarding “liquidated damages” in the contract, one which both you and the Seller are asked to agree to by initialing. Liquidated damages are an amount agreed to in advance as the amount of damages the Seller would suffer if the Buyer were to fail to perform. This is based on the premise that actual damages would be difficult or impossible to calculate. However, in the case of a failed real estate purchase, one often can calculate the damages – if one wanted to.
Many Sellers and even their agents believe that this contract provision is binding, and that once a Buyer has released their contingencies (valid grounds to cancel a sale without penalty), a breach by the Buyer yields a bonus to the Seller, that 3% earnest money deposit. Here’s where we need to look beyond the contract. California statutes govern the enforceability of liquidated damages provisions, and it is made clear by lawmakers that they were meant as a protection to the Buyer, not as a protection to the Seller, and that it is unreasonable for a Seller to receive a windfall unrelated to actual losses.
If both parties sign the liquidated damages provision for no more than 3% of the purchase price, there is a statutory presumption that it is reasonable. However, that is only a presumption- a Buyer may still challenge it by showing it is unreasonable. The reasonableness of liquidated damages depends on the circumstances at time of contract, and the price and terms of a subsequent sale of the property (within 6 months). In a Sellers’ market, where multiple offers abound, the Seller may have difficulty showing any loss. Should the property simply be sold to a Buyer with a backup offer at a similar price, or even at a greater price, the Buyer can certainly contest what the Courts now judge to be a penalty to the Buyer.
So, should you sign a liquidated damages provision at all? Why not just make the Seller prove their damages, which you gamble to be slight? First, you might be wrong about that. While in some circumstances, the Seller may lose little to no money in a cancelled sale, there are instances where the Seller may suffer real losses. What if the market starts to slow down and instead of a quick resale, the Seller is paying holding costs for months, or years? What if the next sale is at a price significantly below what you had offered?- in fact, maybe this is why you decided not to close- maybe you had concerns about value and the direction of the market. What if the Seller lost a valuable opportunity as purchaser of their irreplaceable dream home? The liquidated damages provision, as intended, protects the buyer by capping the Buyers’ liability to that 3% earnest money deposit.
The best reason to agree to a liquidated damages provision – certainty. As a Buyer, you know that you are risking no more than your 3% deposit. In fact, when parties agree to a liquidated damages amount that exceeds 3%, the presumption shifts, and is considered to be an invalid penalty, unless the Seller can prove that it is reasonable. When these situations arise, both Seller and Buyer are required to sign any agreement to release the deposit funds, whether they are being forfeited to the Seller or refunded to the Buyer. The Buyer, if prepared to engage in a legal dispute to challenge the forfeiture of their deposit, will be spending money on attorney fees and may be in for a lengthy battle. The Seller may be unable to resell the property until the issue is resolved. If the Seller simply agrees to release the funds, they still may bring a lawsuit against you for the damages. For these reasons, the parties often compromise on the amount to be forfeited, seeking a fair and final resolution, dependent on the specific circumstances of the transaction. What is important is that you understand and consider these issues before signing that liquidated damages provision or forfeiting your deposit in a cancelled sale.
Please remember, if a legal dispute does arise in your transaction, please seek the advice of an attorney. No matter how good your real estate agent may be, unless they are also an active attorney, they are not licensed or equipped to give you legal advice or to negotiate legal matters.
Disclaimer: This article is intended to be primarily for entertainment purposes, and is not to be considered legal advice.
ABOUT LISA PHILLIPS, ESQ./ CA Dept. of Real Estate, License #01189413
Lisa Phillips is an active Realtor® in the Los Angeles area, with more than twenty years as a Real Estate Broker and Attorney. Lisa is also a member of the National Association of Realtors “Green Resource Council”, and achieved its “GREEN” Designation. Her unparalleled knowledge of real estate, from local markets and pricing to legal issues and deal-making, has made her a trusted and valuable asset to her clients. In addition to her real estate and business savvy, Lisa is passionate about helping others, and works tirelessly for her clients, as well as several charitable causes. For more information, please visit www.LisaPhillipsRealEstate.com.
