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It's The Law: Liquidated Damages Limit Liability

Question:

I am considering making an offer to buy a condo. I am counting on repayment of some money I loaned to a friend to pay for the condo. My Realtor wants me to make an unconditional offer and tells me that my risk is minimal because the contract limits the seller to claiming the deposit if I breach the contract. The deposit is only $1,000. Is my Realtor right?

Answer:

Generally, breach of contract exposes a party to a claim for damages by the non-breaching party. The non-breaching party is entitled to the benefit of the bargain. In other words, the non-breaching party is entitled to be placed in the position he or she would be if the contract was performed.

Benefit of the bargain might give the seller more than one option when suing the buyer for breach of contract. Benefit of the bargain in a real estate contract means the seller is entitled to the difference between what the buyer was going to pay and market value of the property, plus any expenses incurred by the seller due to the buyer’s breach. Additional expenses or damages might include property taxes, interest on mortgages, insurance premium, association dues, utilities, repairs and other expenses the seller would not have incurred if the buyer had. But, these additional damages must have been contemplated by the parties at the time of the original contract. By statute and case law, the seller will also be entitled to interest on the damages from the date they were incurred.

As an alternative to suit for damages, the seller, under a real estate contract, can also sue the buyer for specific performance of the contract. Specific performance of a contract is generally limited to those contracts involving purchase and sale of unique goods. Real estate is considered unique, with no two properties being identical. Hence, at common law, buyers had the right to sue a seller for specific performance when the seller breached the contract. Under Florida law, sellers in real estate transactions can also sue buyers for specific performance. That means, the seller can force the buyer to purchase and, if the buyer does not purchase, the court will order the property sold and enter a judgment against the buyer for the shortfall and any additional damages of the seller.

As in most contracts, the law allows the parties to a real estate contract to limit available remedies for breach of contract One popular limitation in Florida residential real estate contracts is known as liquidated damages. In a liquidated damages clause, the parties agree on a set amount of damages in the event of breach. Liquidated damages can be agreed to for breach by either party, but is most commonly a limitation imposed on the damages and remedies available to the seller.

Liquidated damages must be an attempt to approximate reasonable compensation when actual damages are difficult to calculate at time of contract. In addition, the amount must not be so high as to be considered a penalty or effort to coerce performance rather than an estimate of reasonable damages.

If the liquidated damages amount is deemed a penalty or unconscionable, the courts will not enforce it and the parties will be left as if the contract did not have a limitation on remedies. In determining whether the amount is a penalty, courts frequently focus on the provision as a percentage of contract price. Amounts up to 20% of purchase price seem to be accepted without much difficulty. As the percentage increases, courts become increasingly easy to convince that the amount is actually a penalty and should not be enforced.

Some sharp operators think they can use a clause limiting a seller’s remedy to forfeiture of deposit to maximum benefit by signing a contract that provides for no deposit. In those cases, the seller would have no remedy if the liquidated damages clause was enforceable. That would make the contract illusory. The courts will not enforce a liquidated damages provision without a deposit. Instead, the provision will be ignored and the seller will have the usual contractual remedies.

Wording of the provision is important. Many contracts limit the seller’s remedy to forfeiture of deposits actually made by a buyer. Under Florida law, a deposit actually made includes a check upon which the buyer stopped payment. Other contracts provide that the liquidated damages is all deposits made and to be made under the contract. That can be a big shock to a buyer who thinks he only has $500.00 at risk under a contract requiring an additional $40,000 escrow deposit before closing.

Purchasing real estate is a big financial decision. Contract language may be the most important part of the transaction. Before proceeding further, you should retain an experienced attorney to review and possibly draft a contract or offer to purchase the property you want. That way, you will be protected and understand the terms of the contract you sign.

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