In a new decision, the California Court of Appeal held that a seller was not entitled to keep a nonrefundable deposit in a rising real estate market. In Kuish v. Smith (Feb. 10, 2010), the plaintiff entered into a written agreement to purchase the defendant’s residence for $14 million. After making a $600,000 deposit, the plaintiff unilaterally canceled escrow. The defendant promptly sold the property to a third party for $15 million, but refused to return the plaintiff’s deposit, because the purchase agreement identified the deposit as “non-refundable.”

The Court of Appeal held that the defendant could not retain the deposit, notwithstanding the “non-refundable” designation. The defendant was not damaged when the plaintiff backed out of the transaction, because he was able to sell the property to a third party for more money. Under such circumstances, the court held that retention of the deposit would cause an invalid forfeiture, because it was unrelated to any actual damage suffered. Although contracts may in appropriate instances include liquidated damage provisions, those provisions must be carefully crafted to be reasonable in amount, and are enforceable only when it would otherwise be impracticable or extremely difficult to fix the actual damages. Those circumstances did not exist in the Kuish case.

Implicit in the court’s decision is that if the real estate market had fallen after cancellation of escrow, the seller would have been entitled to retain that portion of the deposit that corresponded to actual damages. But because escrow was canceled in a rising market, the defendant was required to return the plaintiff’s $600,000 deposit, notwithstanding its “non-refundable” designation.

We are continuing to consider how different variations of the facts might have impacted the court’s decision. For example, what if the defendant had not sold the property to a new buyer, but had instead held the property? What if the property value had remained static, rather than rising? What other kinds of damages can a plaintiff seek, other than those relating solely to the value of the property? If you run into these questions, or other variations of the issues discussed in this article, please call us.