Contract Law: California Court rules on non-refundable deposits

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I want to highlight a recent court case ruling that I came across here in California. Since what happens here in California seems to ripple to the rest of the 49 states, I would suggest you take a gander at the following.

Kuish vs. Smith, G040743 [PDF] [DOC]

Mr. Bradford Kuish entered into an agreement to purchase the Laguna Beach home of Mr. & Mrs. William W. Smith, Jr. for $14 Million, but later unilaterally canceled the escrow. Mr. & Mrs. Smith, Jr. then sold the property to someone that had submitted a backup offer for $15 Million but refused to return the $620,000 earnest money deposit to Mr. Kuish relying on the fact that they both signed counter offers stating that the deposit was “non-refundable.”

Mr. Kuish ended up winning his deposit back through the appellate court, but let me expand a bit.

The original court finding was in favor of the Smiths keeping all that deposit but the appellate court ended up ruling in favor of Mr Kuish, and this was the courts response;

Any provision by which money or property would be forfeited without regard to actual damage suffered would be an unenforceable penalty.  To construe the term ‘nonrefundable’ to establish [the sellers’] entitlement to the full deposit without regard to actual damages would essentially create a liquidated damages provision.”

The court ruled that since the Smiths ended up selling their property for $1 Million more after escrow was canceled they did not suffer $620,000 in actual damages because of Mr. Kuish canceling.

Our real estate purchase contracts here in California have a section called “liquidated damages.” This section of the contract stipulates what damages the seller may claim for breach of contract by the buyer, and is usually limited to the amount of the deposit, or is limited to 3% of the purchase price which they both did not agree to.

In my humble opinion I believe Mr. Kuish should never have signed such a clause to make his deposit “non-refundable.” I see where he might have been blinded because this was his dream home. He wanted to make major improvements to the property according to court transcripts and needed time to get local government approvals for his modifications to the beachfront property. This whole escrow lasted 9 months. It was Mr. Kuish who ended up canceling in the end.  My advice to the Smiths would have been to get Mr Kuish to sign the liquidated damages section of the contract, and they would have had an extra $420,000 (3% of the purchase price) in their bank account.

In conclusion, do not sign and do not try to get anyone to agree to a clause stipulating deposits to be “non-refundable”. They will just end up being “non-enforceable” in court. Time and time again this clause just does not hold up in court.

It’s sad that people don’t live up to their agreements nowadays.

Good luck in all you do America.

I welcome your comments.

Photo: JamesBrandon

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.