Daily Development for Tuesday, May 2, 1995

by: Patrick A. Randolph, Jr.

Professor of Law UMKC School of Law randolpp@smtpgate.umkc.edu

Here are a couple of cases on the forfieture remedy in executory real estate contracts. This is an area that differs dramatically from state to state. Some states require an elaborate liquidated damages justification. Some say that liquidated damages must be the sole remedy. Some permit forfeiture of earnest money in virtually every case, regardless of justifaction, and let the seller apply the earnest money if the seller elects to sue for damages instead.

What's the experience in your state?

P.S. I'm getting a bit ahead because I'll be out of town for a week.

VENDOR/PURCHASER; SELLER'S REMEDIES; LIQUIDATED DAMAGES:

Because liquidated damages provision of 10% of the purchase price is reasonable compensation for loss of sale alone, the buyer's agreement to pay an additional amount representing the actual cost of expenses for modifications to the property is valid as reasonably related to additional damages that might be incurred by the seller . Olcott Lakeside Development, Inc. v. Krueger, 616 N.Y.S.2d 841 (App. Div. 1994).

VENDOR/PURCHASER; SELLER'S REMEDIES FOR BUYER'S DEFAULT; LIQUIDATED DAMAGES: Washington Supreme Court establishes standards for liquidated damages/earnest money provisions in real estate contracts. (Two cases) Watson v. Ingram, 881 P.2d 247 (Wash. 1994). Wallace Real Estate Investment, Inc. v. Groves, 881 P.2d at 1010 (Wash. 1994). In these two cases, one a residential contract and one a commercial contract for an apartment site, the Washington Supreme Court clarifies confusion in earlier cases and adopts the simple rule that liquidated damages provisions are valid if they constitute a reasonable attempt to estimate damages as of the time of contract. No recitation of the basis for such estimate is necessary - the facts can speak for themselves. (Wallace) But recitations can help support the conclusion of reasonableness. (Id.). Further, the commercial sophistication of the parties will contribute to a presumption that the damages clause is a reasonable estimate. (Id.) Another traditional element of the Restatement test, the prospective difficulty of estimating potential damages, is not a discrete factor in the Washington test, but may be useful in assessing the reasonableness of the damages actually estimated. In other words, if damages are readily ascertainable, this would not preclude a liquidated damages provision, but would give the parties less latitude as to what the liquidated damages amount could be.

In Watson, the real estate contract had a $15,000 earnest money provision, stated as an optional liquidated damages clause. (Seller could invoke the clause or, in the alternative, pursue other remedies). After buyer's default, seller quickly resold the property for the same amount as the contract with seller. Buyer argued that the seller had no right to invoke the clause because it was clear seller suffered no real damages. Forfeiture of liquidated damages was upheld.

In Wallace, the liquidated damages provision appeared in an initial contract, and thereafter the contract could be extended by supplemental forfeitable payments. The court accepted an economist's testimony that loss the damages amount approximated the loss of investment value of the purchase funds due to the extension of the sale, and thus upheld them as valid.

Comment: Note that many jurisdictions do not apply liquidated damages standards to earnest money forfeiture provisions. If the earnest money clearly is a relatively small percentage of the total value of the contract, the courts permit its forfeiture without an analysis of its validity as liquidated damages and in addition to a damages claim. Washington has a statute that holds that forfeiture provisions in land sale agreements are valid notwithstanding the absence of actual damages if the amount forfeited is not in excess of 5% of the purchase price. The court, for all its efforts to provide clarity to the law, does not clearly define the relationship between this statute and the common law it develops in its opinions.

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