In A Rising Market, Seller Of A Home Cannot Retain A Nonrefundable Deposit From Buyer Who Breached The Purchase Agreement

In Kuish v. Smith, (— Cal.Rptr.3d —, Cal.App. 4 Dist., February 3, 2010), a California Court of Appeal considered whether a home seller could retain a deposit labeled “nonrefundable”, submitted by a buyer who later breached the purchase agreement. The Court of Appeal held that, in the circumstance of a rising market, the seller’s retention of the deposit constituted an invalid forfeiture.

Facts

Bradford Kuish (“Kuish”) entered into an agreement with William and Rhonda Smith (“the Smiths”) to purchase their Laguna Beach home. The agreed purchase price was $14 million. The agreement between the parties required Kuish to make two non-refundable deposits into escrow. The agreement required the first deposit of $400,000 to be made upon the opening of escrow and the second deposit of $400,000 to be made on or before February 12, 2006. The agreement did not contain a liquidated damages clause.

On January 12, 2006, the parties modified the agreement to provide for a total of $820,000 in deposits. However, the parties signed amended escrow instructions on February 13, 2006, which decreased the total amount of deposits to $620,000 and extended the closing date from July 28, 2006, to August 10, 2006. On March 23, 2006, the parties again amended the escrow instructions to extend the closing date to September 15, 2006. Kuish paid the $620,000 deposit on February 13, 2006. Pursuant to the agreement, the escrow company released $400,000 to the Smiths and the remaining $220,000 was held in escrow.

Kuish later requested that the escrow be canceled. The escrow was canceled on October 17, 2006. On November 16, 2006, the Smiths sold the home to a third party for $15 million. Kuish sought return of his deposit but the Smiths refused to return the deposit because they asserted the deposit was nonrefundable under the parties’ agreement. Kuish filed a lawsuit in which he sought return of the deposit. The trial court found in favor of the Smiths.

Decision

The Court of Appeal reversed the decision of the trial court. The Court of Appeal concluded that, in the circumstance of a rising market, the seller’s retention of the deposit- even if labeled as “nonrefundable”- constituted an invalid forfeiture.

Civil Code section 3307 provides the following: “The detriment caused by the breach of an agreement to purchase an estate in real property is deemed to be the excess, if any, of the amount which would have been due to the seller under the contract over the value of the property to him or her, consequential damages according to proof, and interest.” In determining damages for a seller, there is no need to consider whether the buyer who breached the agreement acted in bad faith. The main measure of damages for the seller “is essentially the difference between the contract price and the property’s value at the time of the breach.” The court noted, “During a period of rising property values, when a seller seeks damages from a defaulting buyer, if the property has increased in value before trial and the seller resells the property at a price equal to or higher than the value of the contract, there are no longer any loss-of bargain damages.”

After Kuish canceled escrow, the Smiths sold the property for $1 million more than Kuish had agreed to pay for the property. The Smiths did not claim any consequential damages other than $9,483.15 for damage to the home’s roof that occurred during Kuish’s staking of the property. The Smiths argued that Kuish’s deposit was nonrefundable. The court stated, Kuish’s “deposit would have been nonrefundable in a falling market to the extent [the Smiths] were able to show damages under Civil Code section 3307.” Without the benefit of a valid liquidated damages clause, the seller may retain the deposit only to the extent that actual damages were incurred.” A provision which provides the money “would be forfeited without regard to the actual damages suffered would be an unenforceable penalty.” The court concluded, “To construe the term ‘nonrefundable’ to establish [the Smiths’] entitlement to the full deposit without regard to actual damages would essentially create a liquidated damages provision,” – and the parties stipulated the agreement did not contain such a provision and never argued otherwise.

The court also explained that the trial court erred by concluding that the Smiths were entitled to keep the deposit on the basis it constituted separate and additional consideration for extending the escrow for nine months. Neither the parties nor the amended escrow instructions reflected the parties’ agreement for Kuish to make an irrevocable disbursement of the deposit in exchange for extending the closing date. The nonrefundable deposit term was included in the initial agreement and cannot support separate and additional consideration in support of subsequent agreements.

The court concluded the trial court erred in finding that (i) the Smiths’ retention of the $600,000 did not constitute an invalid forfeiture, and (ii), the deposit constituted separate and additional consideration for extending the escrow.

Questions

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Karina K. Terakura | 916.321.4500