COVID-19 has had far-reaching economic effects that continue to ripple through every industry, and real estate is no exception. In uncertain times, many people who have recently entered into real property purchase contracts find themselves unable or unwilling to complete the transaction. These buyers often risk losing thousands of dollars as their earnest money deposits, which are typically also earmarked as liquidated damages per the purchase contract in the event that they breach the contract. Sellers also face significant damages in this uncertain market if their buyer cancels the purchase contract, potentially above and beyond the liquidated damages. This article will address three of the defenses that buyers have when canceling real estate contracts in an attempt to protect their deposits and cancel without consequence if they have been impacted by the ongoing pandemic.
Liquidated Damages
Liquidated damages provisions in real estate purchase agreements are governed by Civil Code section 1675. Pursuant to that section, liquidated damages amounts are presumed valid if they do not exceed at 3% of the purchase price. Anything above 3% is presumed invalid, and the burden shifts to the seller to prove to the trier of fact that the higher amount is reasonable given the circumstances. In addition, there is protection built in for buyers to avoid the potential for the seller to “double dip.”. Notably, if a seller is able to successfully sell the property within 6 months of the buyer’s breach, the trier of fact may consider that subsequent sale in determining if the liquidated damages are reasonable (for instance, the buyer may recover all or some of their liquidated damages amount if the actual damages suffered by the seller are less than the amount of the deposit or liquidated damages amount, such as when the property re-sells for the same or close to the breached contract).
Force Majeure
California Civil Code section 1511 allows for an excuse to performance on a contract due to “acts of god,” and codifies what is commonly known as the “force majeure” defense. It states in relevant part that: “The want of performance of an obligation, or of an offer of performance, in whole or in part, or any delay therein, is excused by the following causes, to the extent to which they operate… when it is prevented or delayed by an irresistible, superhuman cause, or by the act of public enemies of this state or of the United States, unless the parties have expressly agreed to the contrary…”.
Frustration of Purpose
California law also allows for the frustration of purpose defense to non-performance of a contract. Frustration of purpose can be invoked when the following conditions are met: Performance on the contract remains possible; However, the fundamental reason of both parties for entering into the contract has been frustrated by an unanticipated circumstance; and That circumstance substantially destroys the value of performance by the party standing on the contract.
Impossibility and Impracticability In the event that a buyer is not able to avail themselves of the defense of force majeure, they may assert the defense of impossibility and impracticability. This defense can be raised when a supervening event occurs that makes performance impossible or impracticable, such as the current state of affairs surrounding the pandemic. This defense requires that the event causing the impossibility or impracticability was not foreseeable at the time of entering into the contract.
In conclusion, buyers of real estate who have been impacted by the pandemic may have several legal defenses available to protect their deposits and cancel their contracts without consequence. However, the applicability and success of these defenses are uncertain and may vary based on the specific circumstances of each case.