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When a “Nonrefundable” Deposit Really Is Refundable- Why this Buyer who Bailed got his Deposit Back; Part 1.

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

Law Office of James J. Falcone