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By: Kevin Chiao, Esq. Deleon Realty Palo Alto Specialist

These days, it seems like every small transaction requires long and complex forms filled with legal jargon. It is often difficult to tell exactly what certain contract provisions mean, and even harder to understand how the provisions operate. This may be somewhat acceptable if you are purchasing the newest cell phone, but much riskier if you are purchasing real estate. Buyers and sellers of real estate often sign provisions of a contract simply because their agent has instructed them to do so. One such provision is the liquidated damages section. As agents in real estate with legal backgrounds, we often find that clients lack knowledge of the repercussions of initialing this provision.

At the simplest level, a liquidated damages provision operates to quantify monetary damages at the beginning of a transaction if a buyer breaches a contract. Rather than having to prove damages at trial, initialing liquidated damages provides for a payment of three percent of the purchase price if a buyer backs out of a deal. Theoretically, a seller then only has to prove that a buyer breached a contract and not the amount of damages the seller suffered. Generally, whether or not a liquidated damages clause is enforceable is a question of law. In practice, whether or not liquidated damages will apply turns on the facts of a transaction and if there is a specific statute that would govern that type of transaction.

With respect to residential purchase agreements, the applicable California statute provides that the reasonableness of enforcing a liquidated damages provision shall be determined by taking into account both the circumstances existing at the time the contract was made, as well as the price and other terms and circumstances of any subsequent sale of the subject property within six months of the buyer’s breach. See Cal. Civ. Code section 1671. Additionally, a liquidated damages provision must be separately signed or initialed by both the buyer and seller, and set out in either minimum 10-point bold type or 8-point bold contrasting red type. These technical requirements were intended to make the parties appreciate the consequences of initialing the provision.

From a seller’s perspective, a liquidated damages clause relieves the seller from the often difficult task of having to prove actual monetary loss. Rather than introducing appraisal evidence and other evidence of loss at trial, the seller would only have to prove that a buyer breached the contract. For a seller, the risk of initialing a liquidated damages provision is minimal. However, in a depreciating real estate market a seller may face the possibility that actual monetary loss may exceed the three percent amount provided by a liquidated damages clause.

There can be some benefits of a buyer initialing the liquidated damages clause. It can operate to fix the amount a buyer is liable for in the event of his or her breach. Additionally, in a fiercely competitive real estate market, initialing the liquidated damages clause can usually make an offer more competitive. In certain instances, a buyer may be able to overcome enforcement of a liquidated damages clause if he or she can demonstrate that it was unreasonable under the circumstances existing at the time the contract was made. However, when a liquidated damages clause does not exceed three percent of the purchase price, the provision is presumed valid and reasonable. Thus, buyers should initial liquidated damages with care as they may be at risk for much more than being stuck with a dumpy cell phone.