Windfalls and responsibility for losses

A fundamental premise in law: when you wrongfully cause another person to lose money, you are responsible for repayment of the loss, and nothing more. This economic concept was codified for California real estate transactions in 1872 and remains intact today. [Calif. Civil Code §3307]

However, an equally fundamental premise holds that windfalls are abhorred by all since they are unearned.

These two legal precepts are disturbed by the inclusion of a liquidated damages provision in a purchase agreement. 

A liquidated damages provision (also called a forfeiture provision) in a purchase agreement specifies the amount of money the seller will receive from the buyer if the buyer breaches the agreement. Liquidated damages are limited to 3% of the sales price on an owner-occupied one-to-four unit residential property, a protected class of property.

Use of a liquidated damages provision is an attempt, by its wording, to:

  • limit a buyer’s responsibility for payment of losses they inflict on a seller; and
  • provide the seller with a windfall at the buyer’s expense.

In effect, a contractual liquidated damages provision creates aberrations in the natural expectations held by individuals in the transaction.

The liquidated damages provision comes into play when a buyer fails to close a transaction.

The breaching buyer owes the seller the seller’s actual money losses, expenditures which will not be reimbursed on a resale. Thus, the seller has a claim on the buyer’s good-faith deposit as the primary source for recovery of money losses.

The seller may make a demand for all or a portion of the good-faith deposit at either:

  • the time of the breach; or
  • after closing a resale of the property when a loss, if any, is known.

When a liquidated damages provision is included in the purchase agreement for one-to-four residential units and the buyer and seller both initial the provision, they have agreed by the wording that the buyer’s good-faith deposit is to be forfeited to the seller on a breach by the buyer.

Editor’s note – As a matter of policy, Realty Publications, Inc. (RPI) forms do not contain provisions which work against the best interests of the buyer, seller and broker. As a liquidated damages provision creates wrongful expectations of windfall profits for sellers and are nearly always forfeitures and unenforceable, the provision is not included in RPI forms.

To recover any amounts of the deposit, the seller needs to have actual money losses to justify their retention of any or all of the liquidated damages deposit.

Thus, the total amount of the deposit — arbitrary for losses and coincidental to the price paid — has no legal relationship to the losses the seller may suffer on the buyer’s breach beyond security for the recovery of actual losses.

When an initialed liquidated damages provision is included in a purchase agreement, the breaching buyer avoids the forfeiture called for by challenging the presumed validity of any amount up to 3% of the purchase price.

Further, for the seller to enforce a forfeiture of any portion of a deposit exceeding 3% of the purchase agreement price, the seller needs to challenge the presumed invalidity of the excess by demonstrating in an accounting that their losses on the sale exceeded 3% of the purchase price.

The liquidated damages provision becomes a promise by the seller to refund that portion of the deposit which exceeds the seller’s recoverable losses.

Thus, the seller’s failure to refund (or release) the amount exceeding their losses is a breach by the seller of the liquidated damages provision and the purchase agreement.


Money losses reimbursed

What is the seller’s agent to do about a buyer’s good-faith deposit when the buyer breaches a purchase agreement?

The first step is for the agent to analyze the extent of the seller’s loss of money now that the sales escrow is dead.

The buyer owes the seller the seller’s actual money losses since they are expenditures which will not be reimbursed by a resale. Thus, the seller has a claim on the buyer’s good-faith deposit as the primary source for recovery of the losses.

Calculating the amount of the demand to be made on the buyer is straightforward when the property is resold in the near future.

A seller’s net sheet used to lay out the net proceeds received on the closing of a resale is compared to a seller’s net sheet estimating the net proceeds the seller would have received on the cancelled sale. A comparison of the two amounts will present an accurate representation of the actual money losses the seller incurred due to a decline in property value and the transactional costs not reimbursed by the resale. [See RPI Form 310]


History of the term

“Liquidated” finds its roots in the medieval Latin term “liquidatus,” meaning “…to melt, make liquid, make clear, clarify.” It was first used to reference the clearing away of a debt in 1755.