February 19, 2010

Home Buyer's Deposit in a Rising Market

As the residential real estate market begins to show signs of life, it is worthwhile discussing a recent case about who is entitled to a breaching buyer's deposit in a rising market. Kuish v. Smith (2010) G040743.

In December 2005, the plaintiff/buyer offered to purchase the seller's beach front home in Laguna Beach for the modest sum of $14,000,000. After all contingencies were removed, the buyer unilaterally canceled the lengthy escrow in September 2006 without cause. Two months later, the seller sold the house to another buyer for $15,000,000.

The plaintiff demanded the return of his $620,000 deposit since the seller came out ahead by selling the property for $1 million more. But the seller declined the buyer's request to return the deposit and a lawsuit ensued. The Court of Appeal held that the trial court erred in refusing to return the deposit. The Court held that in a rising market, where the seller could not prove actual damages, the seller's retention of buyer's deposit constituted an invalid forfeiture under Freedman v. The Rector (1951) 37 Cal.2d 16 (Freedman). The Court reached that result despite the agreement by the parties that the deposits were "non-refundable."

The purchase agreement in Kuish v. Smith did not contain a liquidated damages provision. Most purchase agreements in California do contain a liquidated damages provision because of the widespread use of the forms promulgated by the California Association of Realtors, a trade association of real estate agents. The liquidated damages provision in the C.A.R. purchase agreement must be initialed by the parties to become effective. If it is, the buyer may lose his or her deposit up to 3% of the purchase price by breaching the agreement after the waiver or removal of all buyer's contingencies. Civil Code section 1675 governs liquidated damages in the purchase of a dwelling of not more than four units. Under that code section, if the deposit is less than 3% of the purchase price, the breaching buyer has the burden of establishing the amount of the deposit is unreasonable as liquidated damages.

This gets us back to Freedman where the CA Supreme Court held that there are circumstances where a liquidated damages provision will not be enforced: "Since [the seller] resold the property for $2,000 more than [the buyer] had agreed to pay for it, it is clear that [the seller] suffered no damage as a result of [the buyer]'s breach. If [the seller] is allowed to retain the amount of the down payment in excess of its expenses in connection with the contract it will be enriched and plaintiff will suffer a penalty in excess of any damages he caused." (Id. at pp. 19-20). In other words, a rising market may prevent a seller from recovering liquidated damages.

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