Friend or Foe in a Shifting Market? LIQUIDATED DAMAGES

By Colette Thomason, Esq.

A shifting market reveals various issues as time goes on, such as an increase in buyers developing cold feet and breaching their purchase agreements. These buyer cancellations have led to an additional factor sellers must now consider: How much loss will a seller suffer compared to how much can be collected from a buyer.

In a seller’s ideal world, if a buyer were to cancel a contract at, for example, $6.5 million and the home then sells to another buyer for only $5.8 million, the delta of $700,000 (plus carrying costs and attorney’s fees) would magically transfer from the breaching buyer’s bank account into the seller’s bank account the moment the sale closed. In reality, the amount of damages a seller can collect from a buyer is often limited by what is called “liquidated damages,” which can fall far short of actual damages in a declining market due to a state statute. A real estate purchase contract with a liquidated damages clause typically limits the amount of damages a seller can collect from a buyer to 3% of the purchase price, no matter the amount of damage a seller actually suffers. California law deems this 3% reasonable, and a higher percentage typically an unlawful penalty. In the above example, instead of a seller receiving $700,000 in damages, the seller could receive only $195,000 in damages. Not an ideal world for a seller.

Liquidated damages (or limited damages) benefit a buyer in a declining market but they are not mandatory. They can be negotiated just like any other term in a contract. It sounds simple until we realize a beneficial contractual term requires bargaining power, and such power is shifting. If a seller wants the benefit of unlimited damages, they risk losing a buyer before a deal is made. If a seller agrees to liquidated damages, they risk the buyer later cancelling, and then a diminished sales price; after all, homes that are pending for some time and then placed back on the market face the stigma of being considered a “rejected home.” Throw in tech layoffs and higher interest rates, and the result can be a significant loss. How should sellers weigh these risks? How are agents explaining this analysis to their sellers (or buyers) – do they even try?

Keep in mind the initial decision of whether or not to limit damages rests with the buyer when they submit an offer to a seller. A buyer can either initial the provision or leave it blank. If a seller then disagrees with the liquidated damages provision, they will need to counter that offer which is the legal equivalent of rejecting the offer. The buyer could quit negotiating and walk away.

Alternatively, a seller could write into their offer instructions that they prefer no liquidated damages, as they could instruct a buyer to exclude a certain fixture from the sale or to include a seller-occupancy period after closing. Assuming a buyer or their agent reads those instructions, they may get scared off from making an offer altogether or they may feel the bargaining power is in their hands, so they submit an offer on their own terms, not the seller’s.

An aggressive seller may think of this as a litmus test: If a buyer is serious about the home, then why should a buyer care about damages at all? Better to lose the buyer now than lose a buyer after a lengthy escrow period. As a real estate attorney who finds joy in protecting my client’s rights, liquidated damages provisions are not my friend in this market. I want my seller clients to have the ability to recover the amount of damages they actually suffer and to be made whole. However, I also know that sellers want to sell their homes with as many potential buyers and offers as possible. They do not want to scare buyers away, nor do they want to alarm buyer agents who have probably never heard of a seller refusing to accept liquidated damages. Sellers also do not want to gamble what is often their retirement plan on whether their bargaining power is stronger than that of a buyer in this market.

I can’t help but think, though, how committed a buyer would look if they submitted an offer without liquidated damages all on their own. Once we confirmed that it was not an oversight by the buyer’s agent, Michael and Audrey would explain to our sellers that there is a unique strength in that particular offer from a confident buyer that sets it apart from the others.

When a buyer or seller asks their agent a difficult question, the answer is often “we don’t want to rock the boat, so let’s do what everyone else does” merely because the agent is not equipped to discuss the topic. At DeLeon Realty, Michael has in depth conversations with sellers so they understand the strengths, weaknesses, opportunities, and threats of certain contract provisions and of the market itself. The volume that both Ken and Michael, both California attorneys, do for buyers and sellers, respectively, means they know the market in real time, not based on last quarter’s statistics. Other agents do not have this benefit, much less the legal acumen, to explain to their clients what it means to offer, forego, insist on, or otherwise negotiate liquidated damages.

An unfortunate buyer cancellation can be severely worse when a seller wonders how they wound up with damages they cannot collect. Hopefully sellers take this into consideration when they accept an offer.