A California Buyer entered a contract to buy Seller’s California beachfront property for $14 million. The agreement required a total of $620,000 in non-refundable deposits. The agreement did NOT contain a liquidated damages provision.
Buyers backed out of the deal, and Seller sold to someone else for $15 million- one million more that the original contract was for. Seller sued to get back their $620,000 deposit. The trial judge let the Seller keep the deposit.
The appeals court said no- allowing the Seller to keep the deposit would be an “invalid forfeiture.” Here, where the Seller eventually sold for more then the original contract amount ($1 million more), the Seller suffered no harm from the Buyer’s default. To allow Seller to keep the deposit would be a penalty in excess of any damages he caused.
In effect, this would punish the Buyer for partially performing-putting the deposit in escrow- whereas if the Buyer did not make the deposit, he would suffer no penalty. If it was a falling market, the deposit would have been non-refundable to the extent the Seller could have shown damages according to California Civil Code section 3307. But in a rising market, to interpret the nonrefundable term to award Seller the deposit above and beyond any damages the Seller had would make the provision unenforceable.
This was a surprise for the Seller, who thought nonrefundable meant what it says. But, under California law regarding real estate purchase contracts, if the Buyer breaches, the deposit is merely a pool from which the Seller can be paid damages, if any; otherwise, they have to be refunded. In a rising market, there may not be any damages; here, the defaulting Buyer did the Seller a favor.
In this case there was no “liquidated damages” provision. Liquidated damages are damages whose amount the parties agree during the formation of a contract for the injured party to collect as compensation upon a breach.
Why the court did not construe the provision to be a liquidated damages clause (with a different result), and what is required for an enforceable liquidated damages clause, will be covered in Part 2.
Kuish v. Smith (2010) California Ct. Of Appeal, Fourth District G040743