This article helps homebuyers and sellers understand the legal ramifications of a breach of contract.
Market conditions prevent buyers from completing purchases
Since mid-2020, home sellers — and their agents — have had the luxury of their home sales being a sure thing.
Here in California, the housing market continues to experience high competition for a limited inventory of homes for sale, resulting in rising home prices. However, in 2022, home sales volume has begun to slow and price cuts are on the rise.
The historically low interest rates which occurred throughout the pandemic played a big part in allowing buyers to snatch up homes. But interest rates are on the rise now, and a sea change for sellers has already begun.
In other words, what was previously a sure thing — a quick and easy home sale — is now on shaky ground.
With the jump in interest rates and downward sloping home sales volume, home prices are expected to decrease heading into 2023. As prices slide, buyers under contract will spot equivalent homes listed for less and realize they have overpaid. Their reaction will be to pull out and buy the less expensive house — or simply wait for the market to bottom.
Other situations may cause buyers to simply lose their qualifications to buy in today’s slippery housing market, including:
- unexpected job loss; and
- higher interest rates pushing their debt-to-income (DTI) ratio beyond the maximum threshold.
As the above scenarios play out in the next few months, we will see more buyers breaching purchase agreements.
Of course, buyers ought to be mindful of ensuring they do their due diligence before entering into a purchase agreement. This includes allowing a buffer for interest rate increases and being sure of their job security.
But, more importantly, sellers and their agents need to be prepared for when the inevitable happens.
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Liabilities and monetary losses for purchase agreement breach
When a purchase agreement is breached, the implications can range from a mild hiccup to a huge loss. Either way, it will be the buyer’s and seller’s agents running into the battlefield to assist their clients.
During an upward price environment, a breached contract is usually no more than a minor headache for the seller, as it delays the eventual sale of the property. It might actually result in a higher sales price, as they can now relist the property at a higher price.
However, the opposite is true in a falling price environment, when a breached purchase agreement often translates to monetary losses for sellers.
That’s because in the intervening weeks or months from when a purchase agreement is agreed to and breached, property prices will have declined. It may also mean lost money due to longer carrying or operating costs.
What are a seller’s options when they experience monetary losses due to a buyer’s breach of contract?
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No U-turn: liabilities to a seller in a breached purchase agreement
Once more unto the breach for liability
Upon a buyer breach of contract, sellers then need to decide their next step. This may include:
- enforcing the purchase agreement;
- remarketing the property for sale; or
- retaining the property.
The seller is generally responsible for value jumping around after the buyer breaches. Thus, for fund recovery, a money loss needs to be accounted for.
There are liability limitations in a purchase agreement, which include a:
- liquidated damages provision; and
- contract limitation on recovery.
The liquidated damages provision sets the cash deposit as the ceiling amount for recoverable money losses. The latter sets the limit for recovery and creates an agreed limit for this amount in the purchase agreement. [See RPI Form 150 §10.7]
The loss is recoverable by the seller, unless the property does end up being sold for the same price — or more.
The buyer’s deposit
A seller is entitled to recover their losses when the net proceeds for the resale transaction equals less than the gain from the original purchase agreement.
However, the seller needs to account for the loss.
Consider a buyer and seller who entered into a purchase agreement during a time when interest rates were lower. As they hike, the buyer is no longer able qualify at the new, higher mortgage payments. The buyer is forced to back out of their agreement. In the meantime, the property’s valued has diminished, impacting the seller’s bottom line.
This is where the collection of the buyer’s deposit comes in.
The buyer’s deposit — also called the good-faith deposit or earnest money — will be offset by the amount of the seller’s losses. Essentially, the seller may have the right to retain the buyer’s earnest money deposit on cancellation of the purchase agreement.
When a 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, and the accrual of interest is added on top.
Any interest due accrues at the legal rate of 10%. When the seller agreed to an installment sale, the note rate for the carryback paper is the controlling rate. [See RPI Form 150 ]
Forecast for future purchase endeavors
As we head into the next downturn for home prices, real estate professionals need to focus on the potential liabilities for their clients entering into purchase agreements.
Breaches in purchase agreements will increase as we head into the recession, expected to officially arrive heading into 2023. Expect to see declining sales volumes from 2022-2024, with prices bottoming in 2025.
Real estate professionals: have you seen more buyers breaching contracts? Share your experiences with other readers in the comments below!
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