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Additional Thoughts on Deposit Disputes

By David Hamerslough

May 1, 2018

Our current market is generating a significant number of deposit disputes, many resulting from buyers attempting to cancel noncontingent offers. My last article discussed some of the consequences when a buyer attempts to cancel a contract without making their deposit. This article discusses some additional issues I am seeing with regard to deposit disputes where the deposit has been paid. The article assumes that the liquidated damages clause has been initialed.

An issue that often arises is whether the parties are going to negotiate a disposition of the deposit before the property is resold. Whether this is a good decision for the buyer or seller depends on a number of factors (attitude of the parties, their needs, etc.), but consideration should be given to the likely resale price of the property, the relationship of that price to the purchase price and the seller’s original net proceeds, how long it will take to resell the property, and any additional costs and expenses that the seller will incur as a result of that resale. This information will allow the buyer and seller to evaluate whether the seller will be damaged and, if so, in what amount in relationship to the disputed deposit.

This analysis can be important because liquidated damages presumes that the deposit actually paid reasonably represents the damages that the seller has sustained in the event of a breach of contract by the buyer. California law provides that this presumption can be rebutted by a subsequent resale within 6 months. Where a seller resells the property within 6 months and sells for the same amount (or more) than the first sale, the presumption (that the liquidated damages are reasonably related to the seller’s damages) evaporates, and the seller must then prove that despite the resale of the property at the same or higher amount, the seller still has sustained other legally recoverable damages such that the seller may still be entitled to retain the deposit.

California law has not yet addressed whether the seller is entitled to retain the deposit as liquidated damages in situations where the seller resells the property but does so at a loss that is significantly less than the amount of the deposit. Example: the first sale was for $1,000,000 with a $30,000 deposit in escrow; after the breach, there is a second sale for $995,000 with the seller able to close quickly on that second transaction. Attorneys for the principals fighting over the $30,000 often do not look at this situation from the same vantage point.

Buyers’ attorneys typically argue that an accounting should take place and only that portion of the deposit that represents the actual out-of-pocket losses/damages the seller has sustained should be disbursed to the seller, with the balance returned to the buyer. sellers typically argue that if they have suffered any loss/damage, irrespective of the amount or what percentage of the total deposit that loss/damage represents, then that loss/damage entitles them to rely on the presumption that the liquidated damages amount is reasonable and retain the entire deposit.

These arguments over the reasonableness of the liquidated damages often result in the attorneys’ fees becoming disproportionate to the amount of the deposit or to what damages either of the parties may be legally entitled to recover. This is especially problematic when the deposits are relatively small but the parties have very strong feelings about whether there has even been a breach of contract.
Where the deposit has been made but the parties cannot agree on its disposition, it is not uncommon for the parties agree to leave the deposit in escrow for future resolution and check the box on the Cancellation form that provides for this option. Before preparing such Cancellation documentation, several issues should be considered and the parties should seriously consider those issues in consultation with their own qualified California real estate attorney:

First, how long will the title company hold the deposit? Second, will the deposit be held in an interest-bearing account and, if so, who will receive that interest? Third, what form will the title company require to be signed in order to release the deposit? Fourth, what fees and charges will need to be paid to the title company or anyone else as part of any such release? Fifth, who is responsible for those fees and charges, and what source of funds will be used to pay them, etc.?

Title companies differ on how long they will retain a disputed deposit; however, most title companies agree that at some point they will notify the parties that unless they receive mutually consistent joint instructions regarding disposition of the deposit, then that deposit will be interpled into the Superior Court. Interpleading terminates the title company’s further responsibility over the funds and forces the Court to deal with the parties and their disputed funds. Title companies are legally entitled to be reimbursed for their attorneys’ fees and costs incurred in interpleading funds. The minimum fees and costs charged by title companies for initiating an interpleader action is approximately $1,800 but can and often does rise from there. The significance of this to the parties is that these fees and costs will be deducted from the deposit, leaving less money than the parties had originally anticipated fighting over and also requiring the parties to spend more money in legal fees and costs to respond to the interpleader action.

When I’m involved in a deposit dispute and the parties need to remove the deposit funds from a title company, a stipulation is usually signed by the parties identifying a bank account the funds will be placed in, what is required for release of those funds (joint signatures, an arbitration award, or an order of the court), and any other terms and conditions relating to the retention and ultimate disposition of the deposit. Making arrangements with a bank to handle this kind of transaction not only takes time but may also involve having an established banking relationship or otherwise having to pay some type of fee(s). Title companies typically want to be involved in drafting the stipulation because they will want to be released from any liability for their handling of the escrow, the release, and ultimate distribution of the funds. Finally, as noted above, the title company will not release the funds without having all associated fees and costs related to that escrow resolved.

Cancelling contracts, whether justifiably or not, often creates hard feelings between the parties and it is difficult to take those emotions out of the equation. It is important for the principals and their respective real estate licensees, to understand the financial factors that may impact the disposition of the deposit and address those issues as early in the deposit as possible. All too often, the parties are not aware these issues exist and are then faced with making tough decisions under pressure from the title company. It is always a good practice to document any discussions you have with not only your client but also the other broker and/or the title company regarding these issues but the drafting of any agreements regarding the disposition of the deposit should be handled by a qualified California real estate attorney rather than relying on standard forms.