Back out of deal, forfeit 3%

Illustration by Frits Ahlefeldt-Laurvig.

DEAR BERNICE: We are buying our first home in California. Prices have finally come down to where we can afford them. Our agent asked us to review the purchase agreement now so that we wouldn't feel rushed when we are ready to write an offer. One of the provisions called for "liquidated damages." I've never heard of that before. Is this something we should agree to? --Sam K.

DEAR SAM: Congratulations on buying your first home. The "liquidated damages" provision allows the buyer and the seller to agree in advance as to the amount of damages that will be paid in the event of a breach to buy or sell real property. There are quite a few states that don't have this provision in their standard purchase contracts. In California, however, the liquidated damages provision is commonly used in residential purchases and is limited to 3 percent of the sales price.

I can't give you legal advice as to whether this is a good idea for you or not. Nevertheless, I can share what has happened to past buyers and sellers with respect to this provision.

At the company I worked for, we used the standard California Association of Realtors deposit receipt that included a liquidated damages provision. Both the buyer and the seller had to separately initial the provision for it to be valid. We normally collected a minimum of a 3 percent deposit from the buyer. Once the buyer's offer was accepted, the deposit was placed in escrow. Most of our clients signed the provision.

The liquidated damages provision comes into play if you fail to close the transaction by canceling. For example, say that you enter into an agreement to purchase 123 Main St. You have obtained loan approval and you have removed all other contingencies. You then discover that there is a much better deal at 156 Elm St. You decide to cancel your contract on Main Street and buy Elm Street instead. If you cancel the Main Street escrow, you could be sued for breach of contract. When the liquidated damages provision is signed, however, the buyer normally forfeits the 3 percent deposit and both parties walk away.

While this sounds pretty straightforward, that's not always the case in practice. We had one case in our office where the buyers decided to cancel because the prices were plummeting. They did not sign the liquidated damages provision. The cancellation took place after all contingencies in the contract had been removed. (The liquidated damages provision does not normally apply if you were unable to obtain a loan within the time specified in the contract or if you disapprove the physical inspection of the property.) ...CONTINUED

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