The 2020 recession and COVID-19 pandemic ushered in a wave of hasty home purchases from city dwellers looking to escape the high-density (and high-cost) urban lifestyle. But with homes flying off the market, are home shoppers giving themselves enough time to do their due diligence?

Far too often, the answer is no, and agents find themselves scrambling to rescue a client from a purchase agreement. Read on to explore a buyer’s liabilities to a seller when breaching a purchase agreement for property value decreases, operating and carrying costs and losses on a resale.

Bizarro market

Amidst a pandemic and exodus to more affordable areas, California’s housing market continues to see rising prices and sales volume. Low interest rates played a big part in inciting buyers to snatch up homes, but home prices will eventually trend back downward. A buyer’s likelihood of breaching a purchase agreement in that backslide looks to increase in tandem. Prepare for a swell of this phenomenon when home prices bottom out in 2024.

Related article: Inventory falls as demand surges

 As the nation passes the grim one-year anniversary of COVID lockdowns, some new homebuyers are looking back with regret. In pre-pandemic times, 44% of homeowners reported experiencing some regret about their home purchase after closing escrow. Among millennial homebuyers alone, buyer’s remorse increases to 63%. But as the 2020 recession and pandemic stretches on, so too does the evolution of buyer’s remorse.

Comparative market analysis saves one’s hide

To combat this phenomenon and satisfy the special fiduciary duties owed a buyer in a transaction, the all-important sales price requires special attention. The price set in the purchase agreement needs to reflect the agent’s best comparative market analysis of the property’s value at the time escrow is scheduled to close.

Pricing real estate in a recession is tricky; buyers under contract often find themselves spotting an equivalent or better property available at a lower price and realizing they have agreed to pay too much for the property in escrow. The reaction of a buyer in this situation is to cancel the escrow and buy the other property.

This article addresses the conditions that constitute a money loss for a seller when a purchase agreement fails to close escrow without legal justification or excuse — and when these money losses are recoverable by the seller from the buyer.

Contingency and limited liability provisions

No matter the market conditions, consider including contingency and limitation of liability provisions in purchase agreements in order to best protect a buyer in costly last-minute U-turns. This sets a ceiling on the amount of money a seller can recover when a buyer unjustifiably breaches a purchase agreement. Contingency provisions require further approval where limitation of liability provisions do not.

There are two variations of limitation of liability provisions:

  • a liquidated damages provision; and
  • a contract limitation on recovery.

A liquidated damages provision sets the cash deposit as the ceiling amount for recoverable money losses. A contract limitation on recovery sets an agreed-to ceiling amount to the amount agreed to in the purchase agreement. [See RPI Form 150 §10.7]

To remarket, or not to remarket, that is the question

The first thing for a seller to consider when dealing with a buyer in breach and the loss of a sales transaction is whether they prefer to:

  • enforce the purchase agreement;
  • remarket the property; or
  • retain the property.

Note that a seller is generally responsible for any fluctuation in value after a buyer breaches, regardless of whether they retain or remarket the property. For a seller to recover funds from a buyer in breach, a money loss needs to have occurred and been accounted for.

A seller’s total recoverable losses can include operating and carrying costs, increased closing costs, additional resale costs and interest. Money losses, also known as damages, can range in classification from:

  • general (the dollar amount of any decline in the property’s fair market value from the date of breach that falls below the price agreed to in the purchase agreement);
  • specific (costs incurred as a consequence of the breach such as transactional costs, marketing expenses or increased closing costs); to
  • interest (all money or any carryback note the seller was to receive from the date of breach to the closing on resale of the property). [Calif. Civil Code §3307]

Next, credits and offsets are subtracted from any money losses. These are amounts due to the buyer for:

  • implicit rent (rent received from tenants or for the owner’s use the property);
  • any amount of price increase on the sale; and
  • the amount of any reduction in the seller’s expenses on resale.

This is to ensure the seller is not placed in a better financial position than they would have been had the buyer not breached. [Smith v. Mady (1983) 146 CA3d 129]

A further loss in value after a breach

A relisting seller may find that the value of their property has declined below the price set in the original purchase agreement. This is not uncommon during periods of reduced economic activity; the cyclical nature of real estate sales typically knocks down property values below what a buyer agreed just a few months earlier.

Making matters worse, intangible effects like the “fall-out syndrome” of a lost sale can cast a negative aura, deterring some buyers and their brokers. This further dampens the property’s value on the date of breach. [Bouchard v. Orange (1960) 177 CA2d 521]

Should a loss in the property’s value occur, this money loss is also recoverable from the buyer. This loss in value is limited to two different timelines:

  • general damages (the initial decline in value before the breach, also known as a price-to-value loss); and
  • special or additional damages (further decline in value after the breach).

This price-to-value money loss is recoverable by the seller regardless of their choice to enforce, remarket or retain the property — unless the property is resold for the same price or more.

Calculating losses

Remember that a seller is entitled to recover their losses only when the net proceeds on a resale transaction are less than those they would have received under the breaching buyer’s original purchase agreement. The same can’t be said for a property that is resold at the same or higher price than agreed to by a breaching buyer. When the net proceeds from the resale are the same or cash equivalent, or more, general damages are no longer recoverable (nice try).

When a client has suffered a money loss, break out the calculator. Despite the wording or initialing of forfeiture provisions, the seller must account for their actual money losses as a result of the buyer’s breach since a forfeiture of deposits is not permissible. The buyer’s deposit will be totally or partially offset by the amount of the seller’s losses depending on the amount of their total recoverable losses on resale. [Allen v. Enomoto (1964) 228 CA2d 798]

Interest on vacant properties

For vacant unused land or the seller’s vacant residence, a buyer’s breach does not convert the seller’s equity into cash or cash equivalent. This means the seller temporarily retains ownership of the equity, which may change depending on price fluctuations for the property’s market value until resale. Since the seller cannot recover equity here (except by specific performance) can they still collect interest on it?

First, any interest due on the dollar amount of the net equity can 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 would have been received by the seller — up to and ending on the date of resale or trial. Any interest due accrues at the legal rate of 10%. If the seller agreed to an installment sale, the note rate for the carryback paper would be the controlling rate.

When the breached purchase agreement contains a provision limiting the dollar amount of losses the seller can collect, the losses recoverable would be controlled by the agreed-to limit, and the accrual of interest would be added on top.

Strange wilderness lies ahead

While the pandemic has upended the homebuying landscape in the short term, the ongoing 2020 recession threatens to alter it permanently. How these changes will play out remains to be seen, but forward-looking agents understand that flexibility is timeless. It is in the best interest of agents to stay flexible and understand their clients’ liabilities. Agents: bookmark this page for easy access when (not if — let’s be real) a purchase agreement is breached.