The Residential Purchase Contract (“RPA”) imposes on the Buyer and Seller certain obligations, one of which is to deposit their Earnest Money into Escrow. Assuming that this has occurred, before a Seller can ever claim that deposit, they must first establish that:

(1) the Buyer breached the Contract;

(2) they gave the Buyer Notice to Perform;

(3) the Buyer failed to Perform; and

(4) the Seller properly Cancelled the Contract.

Once this is done, Sellers typically feel that the Buyer’s deposit is “Non-Refundable” and should be released to them by Escrow. After all, isn’t that what the Liquidated Damages provision is for? Not quite.

The Liquidated Damages provision at RPA Article 25 (if initialed) provides that if the Buyer fails to complete the purchase because of their own default, the Seller can retain the Buyer’s deposit. The concept of Liquidated Damages is that because it is hard to predict actual damages that may occur in a breach of contract, the parties agree to limit damages to the Deposit. On a 1-4 unit residential property, CA law limits the damages to no more than 3% of the purchase price.

But there is one more part of Article 25 that most Sellers miss: “Release of funds will require mutual signed release instructions from both Buyer and Seller, judicial determination or arbitration award”. This language is repeated in the Cancellation of Contract, Release of Deposit, and Joint Escrow Instruction form (CAR CC). In short, even though the parties agree to liquidated damages, unless the Buyer and Seller agree when a breach occurs, it will take a Court Order or Arbitrator’s Award to get escrow to release the deposit to the Seller.

Further, as set forth in the 2010 decision in Kuish v Smith (181 Cal.App.4th 1419), in a rising real estate market a Seller cannot retain a Buyer’s deposit as liquidated damages and then sell the Property for more. This is an “invalid forfeiture”, ie: a punitive damage. So, even though the facts are clear that the Buyer defaulted, the Seller still might not get the deposit.

So what does a Seller do? As soon as the sale is properly cancelled, if the Buyer refuses to sign the release of the deposit to the Seller, the Seller should immediately seek a court order or arbitration award to get the deposit. If the amount of deposit is $10,000 or less, the Seller can use the fast and less costly path of Small Claims which also avoids any contractual provision to resolve disputes in arbitration.

For over 20 years, the attorneys of BPE Law Group, P.C. have been advising and representing property owners and real estate licensees in dealing with their legal concerns and maximizing their opportunities. If you or your clients would like a consultation, please call our office at (916) 966-2260 or e-mail me at sjbeede@bpelaw.com.