Consider a buyer who breaches a purchase agreement containing a liquidated damages provision, and cancels escrow. The seller is advised by their agent to make a demand on the buyer for the entire good-faith deposit since amounts up to 3% of the price are presumed valid. [Calif. Civil Code §1675(c)]
When the demand for the forfeiture is made on the buyer through escrow cancellation instructions, the buyer may:
- agree to forfeit the deposit;
- challenge the liquidated damages provision as voidable and demand a return of their deposit; or
- demand an itemization of the seller’s money losses to determine the buyer’s liability.
By demanding an itemized list of the seller’s money losses, the buyer makes a legal challenge to the presumed validity of a forfeiture provision for deposits up to 3% of the purchase price.
When a buyer demands their deposit be refunded, the seller is obligated to provide an accounting. In it, they state their losses in dollar amounts. If their unrecoverable losses equal or exceed the amount of the deposit, they can keep the entire deposit under the 3% validity rules. If the losses are less, the seller is not entitled to the entire deposit and is obligated to return the difference. [CC §1675(c)]
If the seller fails to respond with an accounting, they waive any claim they may have to recover their losses.
When challenged, the seller needs to itemize and prove their money losses caused by the breaching buyer. These losses include:
- any decline in the property’s value at the time of the buyer’s breach;
- the seller’s transactional costs incurred on the lost sale which are not recoverable on a resale; and
- any increased operating costs or rent losses caused by compliance with conditions in the purchase agreement and incurred prior to the resale of the property.
The buyer will cover these itemized losses from the good-faith deposit up to any dollar limitation set by a liquidated damages or liability limitation provision in the purchase agreement.
A seller who seeks to recover losses from a breaching buyer who asserts their right to pay only the seller’s actual money losses needs to:
- resell the property, rather than retain the property unsold;
- calculate the total amount of the price-to-value loss, lost transactional expenses and the loss of non-value-added improvements or repair expenditures made to prepare for the closing;
- make a demand on the buyer for the amount of the itemized money losses; and
- if not paid, pursue collection of the lost money and a release of the amount from the buyer’s deposit, subject to any agreed limitation on the dollar amount of the buyer’s liability for their breach.
If the seller decides to keep the property, they have no losses unless they provide evidence of their money lost. The seller may recover their itemized losses from the deposit. The remainder is returned to the buyer.
The 3% threshold
The deposit works as security for amounts owed the seller in the event of actual losses on the buyer’s breach. The recovery of losses is limited to the total amount of the deposit, regardless of amount, under liquidated damages clauses or contractual limitation provisions.
Also know that the good-faith deposit, even if released to the seller after contingencies have been removed, is the buyer’s money until:
- the buyer receives consideration (the property); or
- the deposit is offset by reimbursement to the seller for their actual money losses suffered due to the buyer’s breach, which is best shown by comparisons of the estimated closing statement for the breached transaction and the closing statement on the resale.
Whether the deposit is more or less than 3% of the price is not the issue when it comes to what the seller can keep for money losses. Once challenged by the buyer, the seller has to prove they lost money. No matter the deposit amount as a percentage – more or less than 3% – the seller can keep nothing more than their actual losses.
For deposits up to 3% of the price, it may be said the buyer has to push the issue and get the evidence from the seller to overcome the forfeiture’s validity. The deposit is returned to the buyer to the extent the seller has no losses.
For deposits over 3%, the buyer demands the money without needing proof beforehand. Thus, it is the seller that is required to overcome the invalidity presumption by showing they lost more than 3%.
The end result is in the math – the same whether above or below the 3% threshold. Hence, no forfeitures on any amounts, as the seller is only able to recover money losses. As a matter of law, no part of the forfeiture is invalidated, only that the burden of proof of seller losses less than the deposit amount lies with the buyer when up to 3%, or with the seller on the excess over 3%. Either way, the seller needs to provide proof of their losses.
Bottom line, the seller can’t keep the deposit below 3% of price, unless they can prove they can. That is, they are only entitled to recover their losses on a resale if their demand is challenged under the presumption of validity in the seller’s favor. Also, the buyer can’t get the deposit in excess of 3% of price if the seller can ascertain they are entitled to it by proving their money losses under the presumption of invalidity in the buyer’s favor.