This article dives into various cases when a buyer’s breach of a purchase agreement or escrow instructions produces losses recoverable — or nonrecoverable — by the seller.
To read about the basics of when a buyer’s breach entitles a seller to recover money losses for failure to close, see Part 1.
First, a monetary loss by the seller
Consider a prospective buyer of a residence who before entering into a purchase agreement with the seller is informed the seller has already contracted and is in escrow to acquire a replacement residence. The buyer is made aware the seller intends to use the sales net proceeds to fund their purchase of the replacement residence.
The prospective buyer and seller enter into a purchase agreement, the buyer agreeing to pay cash for the seller’s equity and assume the existing mortgage, called a cash-to-loan transaction. Escrow instructions are prepared and signed, and the buyer’s good faith deposit is placed in escrow.
Later, as agreed, the buyer deposits additional funds in escrow. Although escrow is not yet ready to close, the buyer agrees to the release of a portion of the down payment money held in escrow so the seller can close their purchase of the replacement residence. The funds are released and the seller acquires their new residence.
The seller vacates the old residence they have sold and moves their family and belongings into the new residence.
To consent to the buyer’s application to assume the seller’s existing mortgage, the mortgage holder demands a modification of the interest rate and payment schedule, and the exaction of an assumption fee. No contingency provision in the purchase agreement calls for cancellation for excessive demands by the holder of the existing mortgage to consent to the buyer’s assumption on closing.
The buyer refuses to proceed with the mortgage assumption and cancels escrow. The buyer makes a demand on the seller to return all funds the buyer deposited into escrow, which the seller rejects.
The seller then makes a demand to be paid the funds remaining in escrow. The seller claims the buyer has forfeited all funds since they breached the purchase agreement by not assuming the mortgage.
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Recovering losses is based on accounting
The seller promptly re-lists the property and it is resold for the same price, but on terms calling for payoff of the existing mortgage, requiring the seller to pay a prepayment penalty. The seller also agrees to pay the new buyer’s nonrecurring closing costs and one point on new financing to be obtained by the new buyer. On closing the resale transaction, the seller’s net sales proceeds are less than they were to receive on the sale under the breached purchase agreement.
Can the seller recover any money from the original buyer by either:
- retaining all the funds deposited by the buyer; or
- accounting for offsets against the buyer’s deposits for the seller’s losses?
Initially, the seller is entitled to recover their monetary losses as the buyer breached the agreement. However, the seller needs to account for their actual money losses incurred due to the buyer’s breach. As always, a forfeiture of deposits is not allowed, no matter the wording or initialing of forfeiture provisions in purchase agreements.
Depending on the amount of the seller’s total recoverable losses on the resale, the buyer’s deposit will be partially or totally offset by the amount of the seller’s losses caused by the breaching buyer. [Allen v. Enomoto (1964) 228 CA2d 798]
Money a breaching buyer owes the seller for losses
A seller’s recoverable special losses incurred as a consequence of the breach, summarized here and analyzed later in this copy as offset by actual or implicit rental income, include:
- the operating and carrying costs of the property for mortgage interest payments, taxes, insurance, maintenance and utilities, incurred by the seller after the date of the breach and ending on the close of escrow for the resale;
- the increased closing costs the seller incurred by agreeing to pay the new buyer’s nonrecurring closing costs and financing fees on the resale which the seller did not incur on the sale to the breaching buyer;
- the additional resale costs of the prepayment penalty and garbage fees demanded by the lender on the mortgage payoff; and
- interest on the seller’s net equity from the date the breaching buyer’s escrow was to close to the date of closing on the resale.
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The buyer who interferes with the owner’s resale pays
A seller may diligently re-market the property and still be unable to resell it due to interference from the breaching buyer. Buyer interference with resale efforts typically consists of filing a specific performance action and recording a Notice of Lis Pendens, or taking possession and refusing to vacate.
When the breaching buyer interferes with the resale, the seller recovers any further decline in the property’s value after the date of breach until the buyer stops interfering with the seller’s resale efforts, called additional special or consequential losses.
For example, a buyer sues a seller seeking specific performance of the purchase agreement. The seller claims the buyer breached the purchase agreement by failing to satisfy contingencies as scheduled. The buyer claims the seller breached when they canceled, thus excusing the buyer from further performing. The buyer sues to recover the property and records a Notice of Lis Pendens, which clouds title and interferes with the marketability of the property.
Ultimately, the buyer is held to have breached the agreement and the lis pendens is removed from the record, called expungement.
A seller, whether they attempt to resell or retain the property, generally bears the risk of any fluctuation in the value of the property after the buyer breaches. The breach is the cutoff date for recovery of a decline in value — unless the buyer interferes with the seller’s resale efforts.
However, the risk of loss due to a decline in value after the date of breach is shifted to the buyer until the date title is cleared of the recorded lis pendens — when the seller promptly on the buyer’s breach makes a diligent effort to resell the property and the recording interferes. [Askari v. R & R Land Company (1986) 179 CA3d 1101]
Seller’s expenses post-breach as a natural consequence
A seller who takes the property off the market or lacks a diligent effort to resell it after the buyer’s breach is limited in their recovery of money to:
- their actual transactional expenses; and
- any operating expenses incurred to fulfill the seller’s performance under the purchase agreement which end at the time of the buyer’s breach.
Recoverable money losses the seller may incur as transactional expenditures include:
- escrow and title charges;
- lender charges for beneficiary statements or payoff demands;
- lender or carryback seller charges to process the buyer’s credit clearance, mortgage application or mortgage assumption; and
- other expenses and property reports incurred in reasonable reliance on the buyer’s full performance of the purchase agreement.
Recoverable and nonrecoverable losses
However, ownership and operating expenses incurred by a seller who chooses to either retain the property or delay reselling the property are not recoverable. The seller, as the owner of the property, remains responsible for the expenses of carrying and maintaining the property since these expenses are not incurred due to a buyer’s agreement to purchase or a breach by the buyer — they are incurred because the seller owns the property.
However, some operating losses incurred by a seller due solely to their compliance with the terms of a purchase agreement are recoverable, including:
- the seller’s relocation expenses to reoccupy the property when they vacated after all contingencies allowing the buyer to cancel were eliminated;
- rental income lost after the breach on units left vacant or vacated by the terms of the purchase agreement;
- a crop revenue loss due to the planting season having passed at the time of the buyer’s breach; and
- a price drop on the late harvest of a crop brought about due to the buyer’s breach. [Wade Lake County Title Company (1970) 6 CA3d 824]
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Intended use of net proceeds to buy replacement property
Consider a buyer who enters into a purchase agreement, fully aware of the seller’s intent to acquire replacement real estate with the net proceeds from the sale. Only after all the buyer’s contingencies are eliminated and no uncertainties remain about the buyer’s ability to close escrow, the seller enters into a purchase agreement to buy replacement property. However, the seller does not condition their purchase on the prior “sale of other property.”
The buyer then breaches, and the seller is unable to complete their purchase of the replacement property. The seller incurs expenses and losses to avoid liability for having unconditionally agreed to purchase the replacement property.
Expenses incurred on the replacement property transaction are recoverable since:
- the buyer knew when they entered into the purchase agreement that the seller intended to contract to purchase replacement property in reliance on the buyer’s performance of the purchase agreement; and
- the seller agreed to purchase other property in reasonable reliance on their buyer closing the sales escrow since all contingencies had been removed and no obstacles to closing existed, except for the breach. [Jensen Dalton (1970) 9 CA3d 654]
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Operating losses during the resale period
A seller promptly takes steps to diligently re-market the property for sale after the buyer breaches. The seller incurs operating expenses and carrying costs of the property after the date of breach before reselling the property. These ownership expenditures may be recovered from the breaching buyer, subject to offsets for rent credit, owner’s use, etc.
Recoverable operating losses and carrying costs are limited to those the seller incurs during the period beginning on the buyer’s breach and ending on the earlier of:
- the date a resale closes;
- the trial judgment on the breach; or
- the date of withdrawal of the property from the resale market.
The seller who decides to promptly resell the property and recover any losses from the buyer has a duty to the breaching buyer to limit the operating and ownership losses, called mitigation of damages. To do so, the seller needs to take immediate steps to market the property for resale within the shortest possible time. [Spurgeon v. Drumheller (1985) 174 CA3d 659]
Calculating the seller’s collectible losses
To begin calculating the seller’s net loss, the seller’s costs of maintaining their ownership are totaled. However, the recoverable operating expenses and carrying costs of the property incurred by the seller during the resale period are limited to operating and ownership expenses understood by the buyer to exist at the time they entered into the purchase agreement.
Further, the buyer is due a credit for the rental value of the seller’s occupancy, called implicit rent, and any rental income received by the seller from the property after the buyer’s breach.
Thus, for a seller to recover ongoing losses incurred to carry the ownership of the property before resale or trial, a full accounting of income, expenses and the carrying costs of financing is required.
Interest on recovered losses
A seller is also entitled to interest on the losses and expenditures they recover for the decline in the property’s value, expenses of the breached transaction, resale related expenses and the net carrying costs of the property during the resale effort. [CC §3307]
Unless the purchase agreement states otherwise, the interest is collectable at the legal annual rate of 10%, accruing from the date the recoverable loss or expenditure was incurred, called prejudgment interest. [CC §3289(b)]
When the seller retains the property, no property operating expenses or value losses incurred after the breach are recoverable. No losses exist after the breach to accrue interest.
For the seller who diligently re-markets the property for resale, recoverable resale costs, and out-of-pocket carrying costs of the property not offset by rental income or the rental value of the seller’s use of the property, accrue interest from the date of the expenditures.
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Interest accrual depends on property use
Occasionally the buyer breaches, escrow does not close, and the seller does not receive the net sales proceeds. The accrual question then becomes whether the seller is entitled to interest on their lost net sales proceeds. The answer: interest recovery hinges on the seller’s use of the property at the time the purchase agreement was entered into.
For example, a seller’s use of the subject property falls into one of two categories:
- income-producing property used as the seller’s residence, as the seller’s trade or business (implicit rent) or as a residential or commercial rental; or
- non income-producing property, such as vacant land or the seller’s vacant residence.
Rents received from income producing property and implicit rent for the owner’s use of a property are the economic equivalent of interest accruing on the dollar value of the property. Thus, if the seller were to also receive interest on their equity — net sales proceeds — in income-producing property or property they occupied until it resells, they will enjoy a nonrecoverable windfall. It is a double recovery on the equity in their property in the form of both interest on net sales proceeds and rent, which are economic equivalent values.
The seller who occupies the property until it is resold is charged for the value of their use, called implicit rent. The amount of implicit rent is an offset against all money recoverable from the breaching buyer, including interest on the seller’s net sales proceeds.
Collecting on breached sales of vacant land
For vacant unused land or the seller’s vacant residence, a breach by the buyer is a failure to close escrow and convert the seller’s equity into cash or cash equivalent. Thus, the seller promptly remarketing the property for sale temporarily retains ownership of the property, the price of which may be increasing, decreasing or remaining the same depending on price fluctuations in the local market.
The next question is whether the seller can collect interest on their lost net sales proceeds for their equity in the property?
First, any interest due on the dollar amount of the lost net sales proceeds only accrue from the scheduled closing date of the breached contract — the date the benefits from the breached sale in the form of cash for the seller’s net equity were to be received by the seller — up to and ending on the date of a resale closes or a trial is concluded. Any interest due accrues at the legal rate of 10%. However, when the seller agreed to an installment sale, the note rate for the carryback paper is the controlling rate.
When the breached purchase agreement contains a provision limiting the dollar amount of losses the seller can collect, the losses recoverable are controlled by the agreed-to limit, except for the accrual of interest, an additional amount. [See RPI Form 150]
Read more in the RPI ebook: Due Diligence and Disclosures
