What Is a Liquidated Damages Clause in a California Purchase Contract?

When you make an offer, you usually put down a good faith deposit with escrow. A liquidated damages clause decides, in advance, what happens to that deposit if you back out without a valid contractual reason.

I'm Jeanette Nelson, a REALTOR® with Jeanette Nelson Real Estate, Keller Williams Realty, serving Orange County, Huntington Beach, Costa Mesa, Fountain Valley, and surrounding areas. Before a buyer signs an offer, I make sure they understand where their deposit stands at each step, because this clause is one of the most important lines on the page.

This is general information, not legal advice. A real estate attorney is the right person to explain how this clause applies to your contract.

No. Many California purchase agreements include a liquidated damages paragraph with spaces for the buyer and seller to initial. It applies only if both parties agree to it.

Civil Code section 1677 says the clause is invalid unless it is separately signed or initialed by each party, and, in a printed contract, set out in at least 10-point bold type or in contrasting red print in at least 8-point bold type.

If more than one deposit will count as liquidated damages, Civil Code section 1678 requires a separate signed or initialed agreement for each later payment.

Civil Code section 1675 covers residential property with up to four units that you intend to live in when you sign the contract.

• 3% or less of the price: The amount you actually paid is valid as liquidated damages, unless you establish that it is unreasonable.
• More than 3%: The clause is invalid unless the party seeking to keep the deposit shows the amount is reasonable.

Section 1675 says courts look at the circumstances when the contract was made, and also at the terms of any resale of the same property within six months of the buyer's default.

On a $1,000,000 purchase, 3% is $30,000. If your deposit is larger than 3%, that extra amount gets more scrutiny.

That depends on your situation, and an attorney can advise you. Here is the trade-off in general terms:

• If you initial it, and you default, the seller's remedy is generally limited to keeping the deposit, within the rules above.
• If you don't initial it, the seller's remedy is not limited to the deposit, and the seller could try to prove actual damages.

Sellers sometimes look at whether it is initialed when comparing offers.

If you cancel for a valid reason under the contract, such as a contingency you have not removed, your deposit is usually returned. My article on backing out of a purchase explains contingencies, and my article on what happens if a seller backs out covers the other side. If you need to sell your current home first, my article on making an offer contingent on a sale explains that option.

Escrow needs signed instructions to release money. Civil Code section 1057.3 says the buyer and seller both have a duty to act in good faith so escrow funds go to the person entitled to them when a purchase does not close. A party who fails to sign a release within 30 days of a written demand can be liable if they had no good faith dispute.

If you are getting ready to write an offer, I'd love to walk through the deposit, contingencies and this clause with you, so you know exactly where you stand. Call or text me at 714.366.8575 | DRE: 01397168, or contact me. Jeanette Nelson is a REALTOR® with Jeanette Nelson Real Estate, Keller Williams Realty, serving Orange County, Huntington Beach, Costa Mesa, Fountain Valley, and surrounding areas.