A real estate contract is a private deal between at least two parties. In a sense, it is a form of private law, because it is binding on the parties once they enter into a valid contract. If the contract is breached, the party who committed the breach is obligated to pay the other party the amount that is necessary to restore the non-breaching party to the same financial position that he would have enjoyed had the contract not been breached.
What Are Liquidated Damages?
In the event of a breach, damages for the breach of a contract that lacks a liquidated damages provision will be determined by the parties through negotiation or, if necessary, by a court if the dispute proceeds to a lawsuit. A liquidated damages provision purports to determine these damages at the time the contract is signed; for example, “If Party A commits such-and-such a breach, Party A shall pay Party B $10,000 in compensation.” Generally speaking, liquidated damages provisions can be enforceable in court – but not always.
Compensatory Damages vs. Punitive Damages
As stated above, in a breach of contract case, the goal is to compensate the non-breaching party for his losses. Although in other types of civil cases, such as personal injury cases, punitive damages are possible, what contractual damages are not supposed to accomplish is to punish the breaching party. It is only to compensate the non-breaching party for his actual or reasonably anticipated losses.
How Liquidated Damages Must be Determined in Order to Be Enforceable
California Civil Code Section 1671 deals with liquidated damages. Under Section 1671, a valid liquidated damages clause must specify an amount of damages that appears objectively reasonable at the time the contract was signed. As a consequence, California courts require that the amount of liquidated damages must have been calculated in reference to objective factors, such as the likely decrease in the value of real estate if a certain breach occurs.
Another implication of this principle is that California courts are not sympathetic to arguments like, “Although the amount of liquidated damages specified in the contract was reasonable at the time the contract was signed, this amount is no longer reasonable due to subsequent changed circumstances.” In other words, the parties to a real estate contract assume the risk of changing circumstances by the very act of signing a contract with a liquidated damages clause.
What Happens If a Liquidated Damages Clause Is Found Unenforceable?
If a court finds a liquidated damages provision to be unenforceable, the contract will not be scrapped. Instead, the court will determine damages based on the actual losses suffered by the non-breaching party, just as if the contract had contained no liquidated damages provision in the first place.
CKB Vienna Can Help
The foregoing is only a very abbreviated description of California liquidated damages law as they apply to real estate contracts. There is a lot more to liquidated damages law than what is stated above, and liquidated damages clauses must be drafted with care. If you are facing a liquidated damages issue, either before or after signing a real estate contract, call CKB Vienna today or contact us online to schedule a meeting where we can discuss your case.
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