A liquidated damages clause in a real estate contract is a provision whereby the parties agree in advance to the amount of damages a seller will suffer in the event the buyer breaches the contract. California law provides that a liquidated damages clause is presumptively valid if certain requirements are satisfied.
Any provision for liquidated damages in a contract for the sale of real property which liquidates damages in favor of the seller in the event of the buyer’s breach is invalid unless the contractual provision is separately signed or initialed by each party to the contract as in either in 10-point bold type or 8-point red type. A clause which does not satisfy these requirements cannot be enforced by the seller, but it is not void and can be relied on by the buyer as a limitation on liability. In one case, for example, the parties signed a sales contract to sell a home. The escrow instructions provided for liquidated damages in the event of a default by either party. The clause was not initialed. After the buyer defaulted, the seller resold the property for a substantial loss.
The seller sought to recover the full amount of its loss, and the buyer sought to limit the seller’s recovery to the stipulated liquidated damage amount. Since the liquidated damage clause did not satisfy the statute, the seller argued that it was void. The court held that the failure to meet the statutory requirements was a defense to the enforcement of the liquidated damage clause and that it could be waived by the buyer. If the buyer waived the defense, the buyer could rely on the clause as valid.
When the contract involves the sale of owner-occupied residential property of four or fewer units, a provision in the contract that all or part of the buyer’s deposit shall constitute liquidated damages is presumed valid if the clause satisfies the above-requirements and the amount to be forfeited does not exceed 3% of the purchase price. If the amount paid by a buyer to be held as liquidated damages exceeds 3% of the purchase price, it is presumed to be invalid and the seller has the burden of proving that the amount specified is reasonable. In determining the reasonableness of the amount specified as liquidated damages, the circumstances existing at the time the contract was made are considered, as well as the price and terms of any resale of the property within six months after the buyer’s default.
In the case of all other contracts for the sale of real property, the burden of proof is placed on the party challenging the provision to prove that it was unreasonable at the time the contract was made.
The provision validating a liquidated damages clause in a real estate contract is for the benefit of the buyer, to limit his or her exposure to damages. The provision does not apply to limit the seller’s liability for damages if the seller breaches. The provisions of the statute apply only to limit the buyer’s damages in the event he breaches the contract. When a seller breaches, and the clause purports to limit the seller’s liability, the validity of the liquidated damages clause is governed by the provision which finds such clauses valid, whether or not they are initialed, unless the person challenging the clause proves that it was unreasonable when made.
The inclusion of a liquidated damages clause in a real estate sales contract does not affect the rights of the parties to obtain specific performance.
The foregoing has been prepared for informational purposes only and does not constitute legal advice. The information is summary in nature and does not address any particular situation. Readers should not act upon this information but should instead seek professional advice.
