Liquidated Damages Clauses

Liquidated damages are an estimate of the damages that a seller will incur if a real estate purchaser defaults and the closing does not happen. A liquidated damages clause may be included in a purchase and sale agreement for residential property. The industry norm is a 5% deposit that the seller can retain if the buyer chooses not to close or loses financing. The clause may apply even if the seller actually sells the home for more than he or she would have under the first contract. Why would a buyer agree to such a clause? In some cases, a liquidated damages clause is useful because it limits the damages to which a seller is entitled in case a buyer must default. However, you should consult a Boston real estate attorney at Pulgini & Norton regarding all of the aspects of the transaction when you are buying a home.

Often, a buyer needs to put down an earnest money deposit to show a seller that he or she is serious about buying a home. After the transaction is concluded, these funds can be put toward the buyer's down payment. However, sometimes deals fail to go through. If the parties have negotiated what is called a liquidated damages clause, the seller may be able to keep the earnest money deposit as "liquidated damages." This means that the buyer will not be able to reclaim the deposit unless he or she has a legal excuse.

Liquidated damages clauses in purchase and sale agreements are enforceable when the amount specified is a reasonable estimate of the actual damages that will be incurred by the seller in the event of the seller's breach, and the potential actual damages are difficult to determine. The amount specified should not be a sum that punishes or penalizes the buyer. Nor should it specify a sum that is grossly disproportionate to a reasonable estimate of the actual damages.

Historically, Massachusetts courts would review these clauses to determine whether the specified amount was reasonable as anticipated damages. The court would next determine whether the provisions were fair and reasonable in light of what the actual damages to the seller were. If the liquidated damages were more than the actual damages, the clause would not be enforced. This was called the "second look" approach.

Now, in order to determine the fairness of a liquidated damages clause, a Massachusetts court uses a "single look" approach that examines the circumstances that existed at the time the contract was formed. If the potential damages have been difficult to predict at the time of contract formation, the primary issue for contemporary courts has been whether the deposit and the liquidated damages were a reasonable forecast of what a seller's losses would have been in the case of a breach at the time that the parties signed the contract.

Potential costs that a seller can be expected to have considered in negotiating a liquidated damages clause can include having to wait an uncertain period of time before being able to find another buyer and the possibility that the new buyer would pay less.

A liquidated damages clause has both benefits and disadvantages to sellers and buyers engaged in the purchase or sale of a home. The Boston real estate lawyers at Pulgini & Norton represent buyers and sellers in Cambridge, Hyde Park, Braintree, and elsewhere in Massachusetts. Call us at 781-843-2200 or contact us via our online form for a free consultation with a property transactions attorney.