Even In Hot Real Estate Market, Seller Entitled To Entire 5% Deposit When Buyer Lost Financing

by Rich Vetstein on December 10, 2010 · 3 comments

in Massachusetts Real Estate Law, Purchase and Sale Agreements, Real Estate Litigation

This week the Massachusetts Appeals Court handed down an important decision involving the standard form purchase and sale agreement and a listing broker’s fiduciary duties as the escrow agent. The case is NRT New England, Inc. v. Moncure (click for link). I’m going to break this decision down into 2 blog posts because it’s a lot to cover.

Seller Entitled To Retain 5% Deposit When Buyer Couldn’t Close

The first important part of the decision is that the court upheld the “industry norm” 5% deposit under the purchase and sale agreement as “liquidated damages” when the buyer lost his financing and couldn’t close–even in a hot and rising market (2004) and even when the seller ultimately sold the home for a better price.

“Liquidated damages” is essentially an estimate of the anticipated damages a seller would incur if the buyer defaults and cannot close. The parties under a purchase and agreement agree on a number, typically 5% of the purchase price, as the liquidated damages that the seller is entitled to retain–in case the buyer is unable to close. (The buyer is usually protected under the financing contingency until she received a firm loan commitment).

The typical liquidated damages clause in the Massachusetts purchase and sale agreement looks like this:

If the BUYER shall fail to fulfill the BUYER’s agreements herein, all deposits made hereunder by the BUYER shall be retained by the SELLER as liquidated damages, which shall be the SELLER’S sole remedy at law or in equity.

In the NRT case the seller was scheduled to buy another property on the same day as the closing on his sale–a “back to back.” He needed the proceeds from the sale to use for his purchase transaction. However, when the buyer’s financing fell through, the seller was able to obtain a bridge loan, so he could close on his purchase. And he ultimately re-listed his property and sold it for a higher price. So the seller didn’t suffer that much in damages, certainly not equal to the $92,500 in escrow.

Nevertheless, the court upheld the seller’s entitlement to the entire $92,500 deposit. The court said that it wouldn’t take a “second look” at the liquidated damages amount, finding that the 5% was the industry norm in Massachusetts, and represented a reasonable forecast of damages in the event of a buyer’s default given the considerable risk associated carrying the expense of 2 mortgaged properties indefinitely.

Lesson To Be Learned

The lesson here for buyers is that in almost every case where a buyer defaults without legal excuse–say goodbye to that 5% deposit! And that could be a lot of dough down the tubes. So make sure you have an experienced real estate attorney review your purchase and sale agreement so you don’t find yourself in the same quagmire as the buyer in this case.

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Part 2 will be a discussion about what happened when the listing broker messed around with the seller’s deposit. Two words: triple damages. Uh oh.

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