Liquidated Damages Provisions in Real Estate Purchase Contracts

As a former real estate broker in Florida, I sold a house to a family, which went all the way to closing. At the closing, the seller mentioned that she was billed incorrectly for two death certificates. That one statement caused the buyers to refuse to close on the contract and their earnest money deposit was forfeited. The reason: the buyers didn’t want to live in a house where someone had died, even though the person died in a hospital, not in the house.

The “liquidated damages” clause in a real estate contract is basically to protect buyers from being sued by sellers for damages or “specific performance,” which basically forces the buyers to buy the house. Including a “liquidated damages” clause in your contract, agreed upon and signed by both parties, will limit your liability as a buyer to a specific amount of money, which will be forfeited in the event of breach of contract. At my closing, the buyers deposit was $3,000 (1.5% of the purchase price), which they forfeited.

But, what if the buyer’s deposit was only $500 or $1,000 and the seller has taken their house off the market and inspections have been performed? In some cases, the initial small earnest money deposit may not fully compensate them for the actual out-of-pocket expenses they incur as it nears closing. In this instance, there should be a stipulation in the initial contract that provides for additional deposits to be made by the buyer once the inspections have been performed and the buyer has been approved for the mortgage. The additional amount to be paid by the buyers toward their earnest money deposit should be enough to cover those additional expenses.

There are instances where the buyer will not be in breach of the contract and will receive their earnest money back:

1. If the contract stipulates that mortgage financing has to be approved within a certain period of time (usually15-30 days) and the buyer has timely applied for it but was not approved, then the earnest money is returned to the buyer.

2. If there is a stipulation in the contract that repairs should not exceed a certain amount (usually 3% of the purchase price or whatever amount can be agreed upon) and the repairs which are needed (in accordance with the property inspection) exceed that amount, the buyer can back out and get their earnest money back, or re-negotiate with the seller.

But who gets to hold the deposit? There are options and requirements, which will vary state by state, but it should also be stipulated in the contract:

1. The seller could hold the funds, but that’s not a good thing. If there’s a problem with closing, the seller may not be willing to return your money.

2. The real estate firm could hold the money, but some companies don’t have separate trust accounts and don’t want the hassle, especially if there’s interest involved. However, in some states, it is a requirement for a real estate company to have a trust account for this very reason.

3. A title company, attorney, bank or escrow firm can hold your money, which is probably the best option. But, there should also be a stipulation as to who gets the interest on the money.

What if the buyer breaches the contract but refuses to allow the escrow agent to release the funds? In these instances, a seller could sue for further damages more than the deposit because the release of the deposit is a condition of the liquidated damages clause. Sometimes, it’s better to just give up the deposit than pay additional attorney’s fees and costs to fight it. Obviously, your decision would depend on the amount of the deposit in question.

A real estate salesperson or broker is not an attorney. There are standardized real estate contracts for each state, but as is true with any contract, especially one which will probably be the largest investment in your life, you should have an attorney review and explain it to you before you sign.