What this episode adds to the discussion: See the three categories of money losses a buyer may recover from a breaching seller in lieu of ownership of the property.

In this series, we break down the critical steps every buyer agent must take to protect their buyer. From enforcing specific performance to calculating recoverable money losses, you’ll see how to navigate a seller’s breach with confidence and precision. 

The prior episode covers the seller’s economic motives in a rising market.

General damages, special damages and prejudgment interest

 A buyer who seeks to recover money from a breaching seller, in lieu of ownership of the property, does so based on three categories of money losses:

  • general damages, being money directly expended in the transaction or the monetary value lost in the transaction;
  • special damages, also called consequential damages, being money collaterally lost in the future due to the seller’s breach; and
  • prejudgment interest on all monies recovered. [Calif. Civil Code §3306]

General damages are money losses incurred by the buyer due to their cash expenditures and the value of a lost right to acquire property — a price increase in property over the purchase price.

These money losses directly relate to a buyer’s right to acquire a property they no longer will acquire, including:

  • money advanced by the buyer toward the price of the property, such as deposits held by a broker or escrow, or previously released to the seller;
  • expenses incurred examining title conditions, inspecting the property, verifying operating income and expenses, and obtaining financing, escrow services, engineering and improvement plans, etc., all called transactional expenses;
  • move-in expenses incurred to prepare the property in anticipation of possession; and
  • the price-to-value difference between the price set in the breached purchase agreement and the value of the property on the date of the seller’s breach.

Price-to-value difference on date of breach

Consider a buyer of real estate who enters into a purchase agreement to acquire one of two adjacent lots held by the owner. The purchase agreement contains a provision granting the buyer a right of first refusal to acquire the adjacent lot, also called a preemptive right to buy.

The right of first refusal provision sets the price of the adjacent lot at $900,000 but does not state an expiration date for the right to buy it. Thus, the buyer believes they have the right to buy the adjacent lot whenever the owner decides to sell it. A more formal documentation of the right of first refusal is not entered into, and no memorandum of the right is recorded. The transaction closes.

Many years later, the owner conveys the adjacent lot to another person for $2,000,000. The person who acquires the adjacent lot has no knowledge of the outstanding right of first refusal which was triggered by their purchase.

Thus, the buyer holding the right of first refusal is unable to exercise their preemptive right — triggered by the owner’s decision to sell — and acquire ownership of the adjacent lot from the other person. The person who acquired the adjacent lot is a BFP, barring any recovery of the lot by the buyer.

The buyer claims the owner has breached the right of first refusal provision in their purchase agreement. Thus, the buyer makes a demand for the dollar value of the lost right to acquire the property at the agreed price since they no longer can acquire the adjacent lot.

The buyer’s demand on the owner is for $1,100,000. This loss of money is the difference between the price set in the right of first refusal provision and the value of the property on the date of the breach. The demand also includes interest at 10% (the legal rate) on the amount from the date of the breach until the demand is paid.

The owner refuses to pay the demand. The owner claims the right of first refusal they granted expired prior to the owner’s sale of the lot based on the expiration of a reasonable period of time following the grant since the first refusal right documentation did not contain an expiration date.

May the buyer recover money equal to the price-to-value difference of a sale several years later of the lot covered by the right of first refusal?

Yes! The right of first refusal which the owner granted did not state a date for its expiration. Thus, the date of expiration becomes the date of the death of the owner who granted the right.

More importantly, the right to buy granted to the buyer had not been previously triggered by the owner’s actions to sell. Thus, the buyer never was in a position to exercise the right until the owner triggered the right to buy by their decision to sell the property.

It is the owner’s decision to sell which provides the buyer, when notified of the seller’s decision (which did not occur in our example, creating the breach), with their opportunity to exercise the right — to form a binding bilateral agreement with the seller. Only then may the buyer make the decision and communicate their intent to buy the property at the price on the terms called for in the preemptive right to buy agreement.

The notice of intent to sell

The period following the notice of the owner’s intent to sell controls the buyer’s actions. Until the buyer receives the owner’s notice of intent to sell, the buyer does nothing but wait to see whether the owner ever decides to sell. It is the owner’s delivery of the notice to sell which starts the running of the period for the buyer’s exercise of their right to buy.

When this period for exercise is not stated in the right of first refusal provision, it is limited to a reasonable period of time for exercise of the right. [See RPI Form 162-2]

Thus, the period after the notice is what expires, not the grant of the preemptive right to buy, unless the right of first refusal provision specifically limits the term of the grant.

Accordingly, the buyer’s money recovery of the price-to-value loss is the difference between the:

  • value of the property on the date of the breach, here set by the price the owner received for the property on the resale, the event which triggered the right to buy; minus
  • price agreed to in the right of first refusal provision as the amount the buyer was to pay for the property on exercise of the right to buy. [Mercer Lemmens (1964) 230 CA2d 167]

The buyer prepares to take possession

Consider a buyer who enters into a purchase agreement with a builder to construct a new home. The buyer purchases appliances and upgraded fixtures, which the builder installs.

Later, the builder substantially alters the construction plans for the exterior without the buyer’s approval. The buyer demands the builder complete construction under the plans and specifications as agreed. The builder refuses. Prospective buyers for the property will pay a significantly higher price.

The buyer decides they no longer want the new home due to their conflict with the builder. They unilaterally cancel the purchase agreement as the builder breached the agreement, and they no longer want to acquire the property. The buyer decides to recover money, not the property, from the builder.

Here, the amount of money losses the buyer is owed by the builder include:

  • funds advanced toward the purchase price, including good-faith deposits and monies released to the seller;
  • the price-to-value difference between the price the buyer agreed to pay in the purchase agreement and the resale value of the property at the time of the builder’s breach;
  • expenses incurred to prepare the property for possession, i.e., the expenditures made by the buyer for the additional appliances and upgraded fixtures — limited to the amount they exceed the price-to-value recovery; and
  • interest from the date of the breach on all amounts of money recovered.

Recovering expenditures to occupy

A buyer can recover expenditures to prepare a property for their taking possession when incurred prior to a seller breach. However, a purchase agreement provision needs to specify what improvements the buyer intends to make at the their own expense.

The buyer’s recovery of costs advanced by a buyer for upgrades and additions gives the buyer the benefit of the bargain contemplated by both the buyer and seller when they entered into the purchase agreement.

However, the buyer is not entitled to a double recovery for the upgrades they paid for when the property’s price-to-value increase at time of breach exceeds the cost of the upgrades. Any upgrades are deemed to have contributed to the increase in value.

Expenditures to purchase furnishings incurred by a buyer before acquiring ownership to a home are excluded from recovery. Recovery of personal property expenditures is typically not agreed to or contemplated by a seller when entering into a purchase agreement.

Here, money spent on furnishings is not related to the acquisition of real estate. Accordingly, a prudent buyer agrees to buy furnishings contingent on closing the purchase of the property and delivery of the furnishings to the property.

Special damages, a natural loss result

A buyer whose seller breaches their purchase agreement is also entitled to recover related expenses incurred by the buyer after the breach. These post-breach expenditures only qualify for recovery when they are the natural result of the seller’s breach, called special damages.

For the buyer to recover post-breach expenditures, the seller on entry into the agreement needs an awareness the buyer will incur expenses as an unavoidable natural result of the seller’s breach of the purchase agreement.

For example, consider a buyer who enters into a purchase agreement to acquire an unimproved parcel from a builder. The builder agrees to complete construction of improvements on the parcel and convey the property to the buyer on or before an agreed date.

Before entering into the agreements to sell and construct improvements on the property, the builder is advised that failure to complete construction and convey the property to the buyer by the date scheduled will result in adverse tax consequences for the buyer. Thus, the time for performance by completion of construction and close of escrow is known by the builder before entering into the agreements as a prerequisite for the buyer avoiding profit taxes on a prior sale of other property.

Unless the time constraint is met, the buyer’s prior sale will not qualify for an Internal Revenue Code (IRC) §1031 exemption. Without the exemption, the buyer is required to report profits and incur state and federal tax liability on the profits from the sale.

Related video:

Read more about §1031 reinvestments.

Recoverable special losses, the fallout

The builder fails to complete construction and convey the property prior to the date set for closing. Here, due to the builder’s breach, the buyer is unable to avoid incurring and paying income taxes on the profit taken on their prior sale of real estate used in their trade or business. The buyer is also forced to rent another property (and incur moving expenses) until the construction the builder promised is completed.

Here, the special damages recoverable by the buyer as a money award include:

  • the full amount of the profit tax the buyer paid;
  • the rent paid for the temporary facilities until the improvements were completed (plus the cost of additional moving expenses); and
  • interest at 10% from the date the amounts of rent and profit tax were paid by the buyer. [Walker v. Signal Companies, Inc. (1978) 84 CA3d 982]

Interest due accruing from date of loss

Now consider a buyer who is awarded money losses due to a breach of their purchase agreement by the seller for failure to convey the property to the buyer. The buyer is also awarded interest at the (legal) rate of 10%, accruing from the date the seller breached the purchase agreement, on amounts awarded for:

  • the price-to-value differential lost on the resale value of the property at the time of the breach;
  • money paid toward the purchase price, whether held by the seller, broker or escrow, until the date released to the buyer;
  • funds expended on title examination and other transaction expenses incurred preparing to take title;
  • expenses incurred preparing the property to take possession; and
  • interest accruing from the date of disbursements on further losses logically the result of the breach. [Al-Husry v. Nilsen Farms Mini-Market, Inc. (1994) 25 CA4th 641]

Now consider a buyer who enters into a purchase agreement on a one-to-four unit residential property with a seller. The buyer opens escrow and deposits funds called for in the purchase agreement.

Meanwhile, the seller receives a better offer from another buyer. The seller conveys the property to the second buyer.

The first buyer, whose purchase agreement has now been breached by the seller’s conveyance to the second buyer, is entitled to recover the:

  • amount of the increase in value of the property on the date of the breach exceeding their purchase price;
  • interest on the price-to-value difference at the legal rate (10%) from the date of the breach until paid; and
  • refund of their deposits held either in escrow or by the seller; plus
  • interest on the deposits from the date of the breach to the date the deposits are returned to the buyer. [Rasmussen v. Moe (1956) 138 CA2d 499]

Losses a buyer cannot recover

A buyer’s expenses and losses unrelated to the real estate itself and not intended to be incurred by the buyer under the terms of the purchase agreement are not the responsibility of the breaching seller.

Losses and expenses deemed too remote and speculative for a seller to foresee as obligations on a breach are not recoverable from the seller.

For example, a buyer enters into a purchase agreement to acquire an unimproved parcel of commercial property. The seller knows the buyer plans to develop the property. Before escrow closes, the seller determines a higher price can be had for the property from another buyer and cancels escrow.

Here, the buyer may recover any increase in the value of the land over the agreed-to purchase price on the date of breach as may be reflected by the seller’s resale of the property.

However, the buyer is not entitled to recover profits they might earn had they acquired the land and developed it. Lost profits for the anticipated use of a property the buyer does not acquire are unrelated to the sale. Worse, future operating profits are way too speculative for a buyer to recover. [Stewart Development Co. v. Superior Court for County of Orange (1980) 108 CA3d 266]

Also, lost income from rents a buyer might receive had the seller not breached and the buyer acquired a property subject to a long-term lease are not recoverable. Here, the recovery of lost future rental income is barred in a failed acquisition on a different legal theory from consequential losses. Rents are what give a property its present value as an investment at the time of purchase, a capitalization issue incorporating rents in the value.

Rent produced by income property is a factor, together with vacancies and operating expenses, used to establish the property’s present value — the price to be paid for the property and its flow of rents. To allow a buyer to receive a money award for both the increase in the resale value and future rents from a breaching seller is a double recovery. The buyer by the seller’s breach cannot achieve a better financial position than had the seller performed by conveying the property.

Editor’s note — Stay tuned for the final episode of this series.