Due to COVID-19, many real estate buyers who have recently entered into real property purchase contracts are unwilling or unable to complete the transaction. Reneging buyers have thousands of dollars at risk since earnest money deposits typically equal liquidated damages under the purchase contract should the buyer breach the contract.
Liquidated damages provisions in real estate purchase agreements are regulated by California Civil Code section 1675. They are presumed valid if they do not exceed 3% of the purchase price. Liquidated damages above 3% of the purchase price are rebuttably presumed invalid. The burden shifts to the seller to prove that the higher liquidated damages amount is reasonable given the circumstances. In addition, there is protection built-in for buyers to avoid the potential for the seller to “double dip”. Further, under the Section, if a seller is able to sell within 6 months of the buyer’s breach, the subsequent sale can be considered in determining if the liquidated damages are reasonable. The buyer may be able to recover all or some of their liquidated damages if the actual damages suffered by the seller are less than the amount of the deposit or liquidated damages amount, such as when the property re-sells for the same or close to same amount as called for in the breached contract. Thus, valid liquidated damages provisions cap the breaching buyer’s loss for breach and limit the amount of seller’s recovery as a result of the breach.
California Civil Code section 1511 allows for an excuse to performance on a contract due to “acts of god,” and codifies what is commonly known as the “force majeure” defense. It states in relevant part that:
“The want of performance of an obligation, or of an offer of performance, in whole or in part, or any delay therein, is excused by the following causes, to the extent to which they operate… when it is prevented or delayed by an irresistible, superhuman cause, or by the act of public enemies of this state or of the United States, unless the parties have expressly agreed to the contrary…”
Many contracts have specific clauses that deal with the potential of an “act of god,” however the commonly used residential purchase contracts in California contain no such clause. Therefore, most buyers must look beyond the contract to Section 1511 to determine whether the pandemic constitutes an excuse for non-performance by a buyer.
The pandemic may be an uncontrollable “irresistible” and “superhuman” event completely outside of a buyer’s control. However, it is uncertain whether Civil Code section 1511 applies. California Courts have yet to rule on whether the pandemic meets this legal standard. There are many reasons why closing might be delayed or deemed impossible. Not all of them are covered by section 1511. A buyer’s delay due to concerns about personal safety, the lack of an appraisal, an inability to complete repairs, or even the sudden and unforeseen lack of funding due to a stock market crash, do not automatically excuse performance under Civil Code section 1511.
Despite the paucity of guidance on the application of section 1511 to the pandemic there is a bit of precedent for the applicability of the “force majeure” defense. The 2003 California Court of Appeals case of Timney v. Lin, arose out of the September 11, 2001 terrorist attacks. In that case, there was a delay in the recording of a quitclaim deed due to the events of September 11. The court ruled that the forfeiture of the appellants’ deposit was illegal and invalid because: 1) the time delay by the Buyers which triggered the potential forfeiture of the deposit was deemed to be slight by the court (three weeks); 2) the delay was not the fault of the buyers (but due to the events of September 11); and, 3) the sellers suffered no clearly cognizable damages. The case, however, only dealt with delayed performance, not contract termination. Consequently, the case does not directly apply to many of the contract situations that have arisen due to the pandemic. Buyers must prove that the pandemic is the proximate cause of their non-performance. Voluntary human behavior usually will not suffice.
California law also provides for the frustration of purpose defense to non-performance of a contract. Frustration of purpose can be invoked when the following conditions are met:
- Performance on the contract remains possible;
- The fundamental reason of both parties for entering into the contract has been frustrated by an unanticipated circumstance; and
- That circumstance substantially destroys the value of performance by the party standing on the contract.
Additionally, the frustration must be so severe that it is not considered within the risks that were assumed under the contract.
The frustration of purpose defense requires that a supervising or intervening event destroy the main purpose of the contract. Generally, this defense requires the object [of the contract] be so completely the basis of the contract that the parties understand without it the transaction would make little sense.
Buyers not able to rely on “force majeure” or frustration of purpose defenses, may still be able to prove impossibility if the facts warrant it. Impossibility as a breach of contract defense requires 1) an unforeseen event 2) outside the parties’ control that 3) renders performance impossible or impracticable. Thus. “a condition in a contract, the fulfillment of which is impossible or unlawful …, or which is repugnant to the nature of the interest created by the contract, is void.” California Civil Code section 1441.
Impossibility must relate to something that must be done under the contract, such as completing the transaction to purchase the property by recordation by a certain date but the County Recorder is unable to record documents on that date. It does not relate to the buyer’s ability to complete the transaction. If it is possible to perform the act contemplated by the contract, then impossibility is not a defense absent “extreme and unreasonable difficulty, expense, injury or loss.” If such extreme and unreasonable difficulty can be shown, performance may be excused as impracticable.
California’s shelter in place and regional stay-at-home orders provide some support for the impracticability defense because all non-essential businesses have been shuttered leading to widespread economic effects. However, real estate services have been deemed essential and it is still possible to complete real estate transactions.
California courts tend to hold parties to what they agree to in a contract absent exceptional circumstances. Therefore, each of these defenses is narrow and reserved for extreme hardship. The extent to which any of these defenses will be successful depends on the specific circumstances surrounding each transaction. If you are a buyer trying to cancel a real estate purchase agreement, or you are a seller who has a buyer claiming one or more of these defenses, you should immediately seek advice from qualified legal counsel.
The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.
