Residential condominium developers take considerable risk when developing new condominium projects. These risks are compounded in this challenging economic environment, with increased buyer defaults. Lenders providing construction financing often require presales of units in order to release the funds needed to complete a project. Thus, defaulting buyers not only result in lost sales and increased marketing costs to developers, but can also hinder a developer’s financing and completion of a project, with negative consequences to both the developer and buyers of other units in the project.
In recognition that high-density infill housing development is critically important to our state, particularly in large cities like San Francisco, the California legislature recently amended state law in ways that may assist developers of high-density infill housing.
Effective in 2009, for qualifying residential condominium purchases, the amount of a buyer’s deposit that may be retained by a Seller in the event of a buyer default has been increased to six percent (6%) of the purchase price. This change builds on a 2004 law that already enabled a seller to retain a defaulting buyer’s deposit in excess of three percent (3%) for qualifying condominium projects.
Purchase agreements for residential condominiums typically contain a “liquidated damages” provision, whereby the buyer and seller agree that the amount of the buyer’s deposit will serve as the monetary damages to be retained by the seller in the event the buyer breaches the contract and does not complete the purchase of the condominium.
THE STANDARD 3% RULE
The rule in effect for many years is that a seller may keep up to three percent (3%) of the purchase price as liquidated damages in the event a buyer defaults and does not purchase of the property. This amount is presumed valid under the California Civil Code, such that a seller may automatically keep the 3% deposit upon the buyer’s default, unless the buyer establishes that the amount is unreasonable. Because of the 3% rule, deposits for the purchase of residential property have traditionally been 3% of the purchase price.
BIG CHANGES IN 2009 – DEPOSITS INCREASED TO 6% OR MORE (LARGE INFILL PROJECTS WITH 20 OR MORE UNITS)
Under Assembly Bill 2020 effective in 2009, state law on liquidated damages has been amended significantly:
In the event of a buyer default, six percent (6%) of the purchase price is now presumed valid as liquidated damages that may be retained by a seller from a buyer’s deposit if the following criteria are met:
1. It is the initial sale of the unit
2. The unit is a newly constructed attached residential condominium
3. The unit is in a structure of 20 or more residential condominium units, and over 8 stories high
4. The project is high-density infill development
5. The purchase price is more than one million dollars ($1,000,000) (Minimum purchase price to be adjusted annually beginning in 2010)
6. Condominium purchase agreement must include notice of seller’s right to 6% liquidated damages
A seller may be able to keep even more than 6% of a defaulting buyer’s deposit, but there is a catch.
The Catch. A seller intending to keep a deposit of greater than 6% in the event of a buyer’s default must perform an “accounting” of its costs and revenues related to the construction and sale of the unit, including the cost of the delay caused by the buyer’s default. In order to keep greater than 6%, the accounting must show that the seller’s losses due to the buyer’s default are greater than 6% of the purchase price. If the seller’s losses due to the buyer’s default are not in excess of 6%, then the seller may keep only the standard 6% of the purchase price and must refund the remainder of the deposit to the buyer.
The Details. A seller is required to make reasonable efforts to mitigate its damages as a result of a buyer’s default. If a new qualified buyer enters into a contract to purchase the same condominium at a price greater than or equal to the price to be paid by the original buyer, then the amount of the original buyer’s deposit in excess of 6% that may be retained by the seller will be limited to actual damages incurred by the seller after factoring in the final purchase price of the condominium.
PRIOR 2004 AMENDMENTS – DEPOSITS GREATER THAN 3% (PROJECTS WITH 10 OR MORE UNITS)
The 2009 changes in law described above build on prior amendments to the law that went into effect in 2004. The 2004 amendments are more inclusive and not limited to large infill projects. The 2004 amendments enable a seller to keep greater than three percent (3%) of a defaulting buyer’s deposit as liquidated damages in certain circumstances. To qualify the condominium being purchased must meet the following requirements:
1. It is the initial sale of the unit
2. The unit is in a newly constructed attached residential condominium
3. The unit is in a structure of ten (10) or more residential condominium units
The same “Catch” and “Details” described above apply to the 2004 amendments, except that the operative amount of liquidated damages under the 2004 amendments is 3% of the purchase price. The 2004 amendments also require that a seller comply with the accounting rules and mitigate damages in connection with a new qualified buyer.
The 2004 rules described above remain in effect today. Thus, the seller of a project that meets the requirements of the 2004 amendments but not the 2009 amendments, may still utilize the 2004 rules. Moreover, the changes do not affect the validity of the standard 3% rule for deposits. A minimum 3% deposit is still valid as liquidated damages if the increased amounts described above are not available.
This summary is by no means a complete list of all applicable laws and regulations related to condo purchases and sales, and should not be relied upon as such. For further information, please contact Kevin Rose or Jay Drake at Reuben & Junius, LLP.
Reuben & Junius, LLP is a full service real estate law firm. We specialize in land use, development and entitlement law. We also provide a wide range of transactional services, including leasing, acquisition and sales, financing and workouts, formation of limited liability companies and other entities, subdivision and condominium work