San Francisco Bay Area Real Estate Lawyer Answers, “What are ‘Liquidated Damages’?”

In most residential real estate contracts, you’ll find a paragraph called “Liquidated Damages” that needs to be separately initialed in order to be effective.  Most buyers and sellers do initial this paragraph, but do they fully understand what they are agreeing to?  What does Liquidated Damages mean, and what happens if you don’t initial it?

Of course, the majority of real estate transactions close smoothly (or at least without going to court), but what happens if someone simply refuses to complete the sale?  If the seller backs out, the buyer can sue for “specific performance,” meaning that the court will order the seller to transfer the property.  But if the buyer is the one who backs out, a court can’t force him or her to accept the property.  The seller was only expecting money, so money damages are all the seller can get.

Unfortunately, the amount that a seller has been damaged is often difficult (not to mention expensive) to prove.  And that is where Liquidated Damages come in.

Liquidated Damages means that the buyer and seller agree in advance how much the seller will get if the buyer breaches the contract.  This amount is generally the deposit held in escrow, but there are limits: in California, the liquidated damages amount in a residential real estate transaction cannot be more than 3% of the sale price.

Buyers like the liquidated damages clause because it sets a maximum amount they can lose.  Sellers like it because they don’t have to go through the time and expense of proving their damages if the deal falls through.

The big advantage for both sides of the transaction is avoiding litigation.  Liquidated damages clauses don’t eliminate all litigation, of course, but at least you don’t have to argue over the amount of the damages.

So is initialing the liquidated damages clause right for you?  As with everything in the law, it depends.  As part the preparation or review of a purchase offer, you should consider every aspect, including whether you are better off with or without the liquidated damages clause initialed.  If you have questions, contact our San Francisco Bay Area real estate attorneys at (650) 422-3313.