The Consequences of Breaching A Contract
By David Hamerslough
You’re the listing agent. Multiple buyers have made offers. One of these offers is for significantly more money than others. It’s an all-cash, zero-contingency offer, and liquidated damages and the arbitration clause have been initialed. Escrow is to close within 21 days. The sellers are ecstatic and are making plans for their next move.
Shortly thereafter, the buyers announce that they are not going to complete the purchase. For the purposes of this article, their reason is not significant. What is significant is that your sellers are shocked. They ask, “How can they just back out like that? What are the consequences? Can we force them to buy the property? How will we ever be able to resell it for as much as they agreed to pay? We were counting on that money for our next move.”
The foregoing are just some of the questions I’m sure most of you have heard and have had to deal with in this situation. This article will answer some of these questions from a legal and practical perspective.
The first reality that a seller must face is that a buyer can breach a contract as long as they are willing to accept the consequences. What those consequences are depends on the terms of the contract. In this transaction, the measure of damage is set by the initialing of the liquidated damages clause. Assuming there is a breach, the seller is entitled to recover the deposit actually paid up to 3% of the purchase price. If the deposit was increased at some point and required an RID-11 and none was obtained, the seller may not be able to recover that portion of the increased deposit. If no deposit was ever made, even though the contract required one, there are several possible arguments that may be made by the parties. One is that the liquidated damages clause does not apply and breach of contract damages do.
Can the seller sue for specific performance? The answer depends initially on whether a PRDS contract or C.A.R. contract is used. Under PRDS, the liquidated damages clause, if initialed, represents the sole and exclusive remedy for the seller. This means that specific performance is not available. Under the C.A.R. contract, the language is less specific, and an argument can be made that specific performance is an available remedy.
Even if this remedy is available under the C.A.R. contract, there may be legal, equitable, and practical issues. Specific performance is an equitable remedy and may be hard to obtain if the breaching buyer has a sympathetic reason for their breach. If the contract price exceeds the fair market value of the property, specific performance might be denied. Another factor that may affect obtaining specific performance is the ground for the alleged breach. Often, buyers claim some defect or deficiency in the property that the seller failed to disclose. Depending upon the strength of such a claim, an arbitrator may deny specific performance.
A seller must be ready, willing, and able to transfer title in order to obtain specific performance. Many sellers cannot afford to hold the property while a specific performance action is pending. If that is the case, and the seller resells the property, then specific performance is no longer a remedy, because the property will not be available for a court or an arbitrator to compel a buyer to purchase. In that instance, the seller’s remedy will be the deposit actually paid if the liquidated damages clause has been initialed. If the liquidated damages provision was not initialed, or if a court were to accept the argument that it didn’t apply because no deposit had been paid, the measure of damage for breach of contract is the difference between the contract price and the fair market value of the property on the date of the breach. Where the property has resold within a relatively short time from the date of the breach, the resale price will often set the fair market value as of the date of the breach. Where a longer period has passed, it may be necessary to retain an appraiser to attempt to set this value.
Finally, there is the question of whether an arbitrator or a court will force a buyer to complete the purchase of the property as part of a specific performance action. There can be a major problem when the buyer does not have the financial wherewithal to complete the purchase; while the court can order the seller to convey title and the buyer to pay the purchase price, if the buyer refuses to pay, it can be difficult for a seller to enforce collection of the specific performance award. In these circumstances, the property will be sold at a sheriff’s sale, with the proceeds to apply toward the price due to the seller. If the buyer cannot complete the purchase or the property does not resell for the original contract price, then the seller must collect the balance of the purchase price from the buyer by collecting on a monetary judgment. In effect, what the seller has accomplished is a forced sale of the property at what might be a lower price than the original sale price combined with a monetary judgment against the buyer. Finally, if the property has been sold at a sheriff’s sale, the buyer would have a right of redemption of up to one year in the event there is a shortfall between the original contract price and the actual sheriff’s sale price.
To illustrate some of these concepts, let’s look at our example. The offer made by the breaching buyers was significantly higher than the other competing offers. To illustrate these remedies and how they may impact a seller, let’s add some hard numbers. The offer that was accepted was $1 million with a 3% deposit of $30,000.00. The range of other offers was between $880,000.00 to $900,000.00. When the property resold, the resale price was $900,000.00. The sellers are counting on the sale proceeds to make their next move and can’t believe that their remedies are limited to the $30,000.00 deposit set by the initialing of the liquidated damages clause. They ask what their damages would have been had liquidated damages not been initialed. The answer is, the difference between the contract price ($1 million) and the value of the property on the date of the breach ($900,000.00, assuming that the resale value is close in time and is accepted by the court as the fair market value as of the date of the breach) for a damage claim of $100,000.00.
Under breach of contract damages, the sellers would also be entitled to consequential damages, including, generally speaking, costs of resale, etc. Attorneys’ fees and costs are recoverable in the event that either arbitration or litigation is required to obtain these remedies. On the other hand, if the buyer agrees to forfeit their deposit, attorneys’ fees would generally not be recoverable, because no arbitration or litigation would be necessary to obtain that recovery.
The next question your sellers ask is “Why was the liquidated damages clause initialed?” The transaction documents generally reflect one of two scenarios. In the first, electronic signatures have not been used. Often, the liquidated damage and arbitration clauses are highlighted for initialing by the seller, or an arrow or post-it note is placed adjacent to where the signatures need to be affixed. If electronic signatures have been used, the platform currently being used for C.A.R. and PRDS automatically has flags for the seller to initial the liquidated damage and arbitration clauses. These platforms require that an agent go into the system to manually de-activate these flags. Another issue is whether there has been any direct communication or discussion between the listing agent and the seller about the consequences of initialing these clauses. What discussion, if any, occurred on these subjects takes on a new significance in this type of situation.
If the buyer and seller cannot resolve their dispute and proceed to arbitration, the only parties bound by the arbitration clause, if it is initialed, are the buyer and seller. The brokers do not have to participate and cannot be compelled to participate in arbitration. In our hypothetical case, our sellers soon discover that they are on their own, and, generally speaking, they are not thrilled about that prospect, having convinced themselves that they relied on the listing agent’s guidance for all of these choices and remedies. If they are frustrated enough and want to pursue a claim against the listing broker, they soon learn that neither the purchase contract nor case law provides a basis for the recovery of attorneys’ fees in any such claim against the listing broker/agent. When a seller reaches this level of frustration, one can assume that a client relationship has been lost, as well as the opportunity for any future referrals.
The consequences of a breach of contract start with the choices made in the contract itself. The next time the opportunity arises to discuss – and have a seller consider – liquidated damages and/or arbitration, some of the factors that should be taken into consideration include whether the offer is significantly higher than any competing offers or current market value, how are market values trending (e.g., are they softening, going down?), how long it will take to resell the property based on those trends, will the property appraise for the contract price (and, if not, how are the parties going to address that fact and what impact will it have on the parties’ expectations and future decisions?), whether a specific performance action will be possible and practical, and whether any such action would take place in Superior Court or via arbitration.