Revisiting the Consequences of Breaching a Contract
By David Hamerslough
March 13th, 2018
Several years ago, I wrote an article about the consequences of breaching the Purchase Contract from a seller’s perspective. In this article, I will discuss that same topic from the buyer’s perspective. I was prompted to do so by at least five cases I have recently worked on, in which buyers have cancelled their non-contingent contracts with sellers shortly after ratification. In each case, the buyers cancelled without making the initial deposit required by the contract. Each buyer believed that the liquidated damages provision would still apply because that paragraph was initialed by the Parties.
In most of these situations, the buyer assumed that they did not have to make the deposit because they had elected to cancel the contract and it would be futile to do so. They also assumed that the market would somehow protect them because the seller would be able to resell the property for the same, or more, money. They further assumed that they had some advantage over the seller because it would be more difficult for the seller to recover money from them since there was no deposit tied up in escrow.
Unfortunately, many of these assumptions may not be reasonable and/or may be impacted by other factors. Before I point out why and outline the possible consequences to the buyer, there are some practical considerations that a buyer should consider before anyone advises the seller or listing agent of the intent to cancel, before a decision is made to not make the initial deposit, and definitely before a signed cancellation is sent to the seller or listing agent.
The first issue to consider is why is the buyer cancelling? Is it due to buyer’s remorse or to a significant personal reason such as a health or family issue or, perhaps, a job-related situation?
Second, what is the anticipated response of the seller? While many sellers are going to be upset that a buyer is cancelling and may want to recover damages from the buyer, there are some sellers who may have a different reaction based upon the reason for the cancellation and/or whether or not there are other interested buyers. Depending upon these and possibly other factors, what is the most effective way to communicate this information and request to cancel the contract (e.g., through a preprinted cancellation form or via a more personal form of communication)?
Third, is there a contractual or other legal basis for cancelling the contract (e.g, incomplete disclosures, mutual mistake regarding an issue or condition at the property, or a lack of disclosure by the seller, etc.)?
Whatever the potential bases for cancelling the Contract, buyers should consider consulting with a qualified California real estate attorney before any position or statement is transmitted to the seller by anyone. Once the buyer is committed to a position on the issue of cancellation, the bases or grounds for the cancellation, whether the deposit still needs to be made, and/or the form used in conveying that position, it will be difficult for the buyer’s attorney to take another approach in any future dispute over the transaction; thus, great care is needed when deciding precisely what the seller should or should not do or say.
Other factors that may be taken into consideration prior to conveying any information to the seller or listing agent about the buyer’s position include but are not limited to what overbidding, if any, occurred, the relationship of the buyer’s contract price to any other offers submitted by competing buyers, market trends, the reasonable likelihood the property can be resold for the same price and in what timeframe, whether liquidated damages have been initialed, whether the deposit has been put into escrow, and, if not (and considering some of these other factors), the likely losses that the seller may sustain upon a resale of the property, such as price differential, carrying costs and possibly losing the opportunity to buy another property or secure the tax benefits available in a 1031 exchange.
The assumptions that many buyers are making regarding liquidated damages may be unreasonable. California law (Civil Code Section 1675) as well as the language in both the PRDS and C.A.R. purchase contracts require that for the liquidated damages provision to apply, not only do the buyer and seller have to initial that clause, but the buyer must also actually put the deposit into escrow. While there is no California law directly on point, most of my colleagues and I believe that if the deposit is not actually paid, then the buyer may not be able to receive the protections afforded to buyers by the liquidated damages clause: specifically, the clause sets a cap on the amount of damages the buyer may have to pay in the event of a breach of contract, which is limited to the deposit paid or 3% of the purchase price, whichever is less.
What is often forgotten in real estate transactions is that if the liquidated damages clause does not apply, then there is no limit on the damages that the seller can recover in the event of a buyer’s breach of contract. The damages that the seller can seek in the absence of the liquidated damages cap includes the difference between the contract price and the value of the property on the date of the breach plus consequential damages. This is where the amount of overbidding by the buyer and the relationship of the buyer’s offer to other offers may have significance. If the buyer has a contract price that far exceeds that of his competition or the other offers are all within a narrow range, then the damages the seller will seek for breach of contract can well exceed the limit that would have been established had the deposit actually been paid into escrow and liquidated damages initialed by the parties. This is because the fair market value of the property may be determined on the basis of what the other competing buyers offered or a range based upon those competing offers.
There is another potential issue depending upon which contract form has been used. If the PRDS liquidated damages clause is initialed and the deposit is actually paid, the PRDS contract liquidated damages clause provides that the deposit shall be the sole and exclusive remedy for the seller. This means that specific performance is not available. However, the C.A.R. liquidated damages language is less specific, and an argument can be made that the seller can still seek specific performance. There are numerous other factors, including legal, equitable, and practical ones, that may prevent the seller from seeking specific performance, but it is a potential remedy available to a seller if the C.A.R. Purchase Agreement form was used.
Regardless of whether or not there is a cap on the maximum amount of damages that a seller may recover for a buyer’s breach of contract, no one should forget that in addition to the damages discussed above, the principals are still entitled to seek recovery of their attorneys’ fees and costs. These sums can mount up quickly if there is a mediation and, if mediation fails to settle the case, then either binding arbitration or litigation in Superior Court. In addition to the obvious expense of these disputes, all of these legal steps create significant stress and take up huge blocks of time on the part of the principals, as well as on the part of the brokers and agents who represented those parties.
Finally, there is the uncertainty and risk that come with any legal dispute. Often, there is an equitable component to a dispute, including disputes over the issues identified in this article. The experiences and perspective of the person deciding a dispute may have an impact on the outcome as well. The motivations for the buyer’s cancellation, the impact on the seller, the age of the parties, and any number of other factors can impact the equities between the parties as well as their legal rights.
The consequences of a buyer’s breach of contract actually start with the choices made in preparing the Contract and whether, among other things, the buyer has performed by making the required deposit. Although any buyer can elect to breach a contract if they are willing to take the consequences, it is critical that a thorough evaluation of those consequences is made with the assistance of a qualified California real estate attorney. An understanding of the full scope of consequences should be ascertained before any discussion of cancellation with the seller or listing agent occurs and before any decision to not make the deposit is made.