When buyers and sellers sign a purchase agreement to transfer a piece of property, they typically do so in good faith. But what happens when buyers get cold feet? What happens if there’s a misunderstanding and the parties cannot come to an agreement?
Before I continue, here’s my disclaimer: I’m about to cover a topic that requires far more than 700 words. I’m going to talk about things like liquidated damages, mediation, and arbitration. If you need to embark on any of these, please ask your Realtor for a copy of the California Association of Realtors Q&A on these subjects. After you’ve read it, if you have questions, consider scheduling an appointment with your attorney.
With that said, let us proceed.
In California, courts don’t like it when buyers and sellers negotiate a non-refundable deposit. Realistically, they won’t enforce such an agreement, so when a buyer makes a deposit on the purchase of a house and backs out for no reason, the sellers are likely to be forced to return the deposit unless they can specifically prove how they were damaged—a time consuming and expensive process.
What the courts will enforce is a liquidated damages clause in your purchase agreement. This clause basically says, “Because it would be difficult to determine the damages if the buyers cancel this transaction without due cause, both parties agree that a good approximation of the damages is equal to the amount of the deposit (up to a maximum of 3 percent of the purchase price on residential properties).”
If a buyer withdraws based on contingencies outlined in the offer (e.g., the loan falls through, inspections find unexpected problems, or his house doesn’t sell), he gets the full deposit back. That’s the whole point of contingencies. If, however, he withdraws his offer for reasons not outlined in the purchase agreement or he has already removed the contingencies, he would not be entitled to the liquidated damages portion of the deposit.
Before you agree to a liquidated damages clause in your purchase agreement, consider it carefully. It also limits the money a seller can get back if a buyer walks away from the agreement. Discuss it with your Realtor. Review the California Association of Realtors Q&A. Talk to an attorney. A liquidated damages clause may be an excellent idea, or it could be an expensive mistake.
Just because a buyer doesn’t back out of a purchase agreement doesn’t mean the buyer and seller will become best friends. Once an escrow closes, the buyer and seller can find themselves at odds with one another. If the disagreement is significant enough to warrant the cost, I strongly recommend pursuing mediation, a process whereby a professional mediator listens to both sides and tries to help the parties come to an agreement to settle the dispute. It typically leads to a far easier, cheaper, faster, and better outcome. The standard California Association of Realtors property purchase agreement requires mediation before court action, so if after signing the contract you refuse mediation, you will be forced to forego attorney’s fees you may have otherwise been entitled to.
If mediation doesn’t work, another option is arbitration.
You will find many real estate and legal professionals reluctant to recommend arbitration. It is usually cheaper and faster than going to court, but has different legal rules than court action. Typically, the results of arbitration are legally binding on both parties, not subject to court appeals—even if legal mistakes are made during arbitration. However, a process that could take years to resolve in court could be resolved in months or even weeks in arbitration. Before you sign an arbitration clause, be careful because the consequences are significant.
Be aware, there are exceptions to the rules regarding liquidated damages, mediation and arbitration. Please read the California Association of Realtors Q&A for details.
If you have questions about getting into real estate, please contact me at firstname.lastname@example.org or call (707) 462-4000. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 40 years.