If you plan to buy or sell a residential home in California, you will likely use the California Residential Purchase Agreement and Joint Escrow Instructions (RPA-CA) contract to specify the terms of the deal and how they will be executed.
This contract includes a Liquidated Damages clause, which is designed to protect both the buyer and the seller should the buyer not fulfill their obligations under the terms of the contract (default). For buyers, a liquidated damages clause limits their loss if they need to backout of the deal; For sellers, they compensate for time and money lost while the property was off of the market, and ensure those funds are delivered in a timely manner.
Liquidated Damages Clause in the RPA-CA
In the California Residential Purchase Agreement, Section 21, Remedies for Buyer’s Breach of Contract sets an agreed-upon amount that the buyer will owe the seller in the case of a default:
If Buyer fails to complete this purchase because of Buyer’s default, Seller shall retain, as liquidated damages, the deposit actually paid. If the property is dwelling with no more than four units, one of which Buyer intends to occupy, then the amount retained shall be no more than 3% of the purchase price. Any excess shall be returned to the Buyer. Except as provided in paragraph 14H, release of funds will require mutual, signed release instructions for both Buyer and Seller, judicial decision or arbitration award. At the Time of any increased deposit Buyer and Seller shall sign a separate liquidated damages provision incorporating the increased deposit as liquidated damages.
If signed, this clause implies that if the buyer breaches the terms of the contract, they will lose the lesser of their deposit or 3% of the purchase price (if property has less than 4 units).
In the absence of the Liquidated Damages clause, the seller would have to prove the amount of costs incurred when the buyer breached – a costly and time-intensive process for both parties. The intention of this clause is to save both sides the legal burden of resolving these types of issues in court.
Getting Out of the Deal Without Breaching the Contract
If you are buying a house, signing a contract does not necessarily mean that you are obligated to buy the property. More often than not, buyers will opt for an inspection contingency period – a time in which they can evaluate the condition of the property and the cost for repairs. You will still have time to backout of the deal during this agreed-upon period without paying liquidated damages.
Additionally, if you are taking out a mortgage, there will be a contingency period – a time-period that the lender uses to assess the condition of the property. After receiving the estimated value of the property from an appraiser, the lender will finalize the loan amount that you will have access to for this particular parcel. If this amount comes out to be less than you expected, you can walk away from the deal without any negative consequence.
With that said, once contingencies are removed, should you need to default on the contract, you will have to pay liquidated damages if the clause above is signed.
What If the Seller Defaults?
It’s not as common for sellers to default on the contract, but it does happen. The liquidated damages clause above only applies to the buyers, which means that buyers and sellers will have to come to an agreement with mediation or arbitration if they want to avoid going to court.
It is situations like these when the arbitration clause becomes increasingly important. You can read more about that here.
Please note: The information contained within this article is provided for informational purposes only and is not intended to substitute for obtaining accounting, tax, legal or financial advice from a professional accountant or lawyer.
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