Real estate developers who intend to sell residential units in larger condominium buildings should be aware of a change in California law as of July 1, 2014 with respect to liquidated damages in purchase contracts. Specifically, developers of certain larger scale projects will no longer be able to include liquidated damages provisions in an amount that exceeds 3% of the purchase price without concerns as to enforceability. Liquidated damages are a specific damages amount set forth in a purchase contract – typically the amount of the deposit- which a seller is entitled to automatically if the buyer defaults. California Civil Code Section 1675 (“Section 1675”) governs certain standards for liquidated damages provisions, including a maximum calculation which is presumed to be valid and reasonable.
Section 1675 provides for a presumption of validity if the amount of liquidated damages does not exceed 3% of the purchase price. If such sum does exceed 3% of the purchase price then the provision is invalid and unenforceable unless the party seeking to uphold can establish that the amount actually paid is reasonable. Projects with 10 or more units can stipulate an amount more than 3% of the purchase price but the seller needs to perform a detailed and timely accounting upon the buyer’s default and provide a refund to the buyer of any amounts in excess of the greater of 3% of the purchase price, or the total of seller’s damages resulting from buyer’s default. After the accounting is complete, the amount is presumed reasonable if it does not exceed 3%, unless the buyer proves otherwise. Sellers typically set the deposit as 3% of the purchase price in order to ensure the liquidated damages provision will be upheld.
However, in 2008 the California legislature passed a bill, AB 2020, which added a temporary provision to Section 1675 granting an exception for certain larger scale projects, specifically that their purchase contracts could include liquidated damages of up to 6% of the purchase price and still be considered valid, unless the buyer could establish the amount was unreasonable. These projects are defined as those which are 20 or more residential units, standing over 8 stories high, a high density infill development, located in a city or county with a population density of at least 1,900 residents per square mile and involve a buyer who pays a purchase price for the condominium unit of more than $1,000,000 (which amount has been adjusted annually by the Bureau of Real Estate). Like the provision applying to projects of 10 or more units discussed above, a purchase contract in a project that meets these requirements can still provide for liquidated damages higher than 6% of the purchase price, but the seller is required to complete a detailed accounting upon the buyer’s default and provide a refund to buyer of any amounts in excess of the greater of 6% of the purchase price, or the total of seller’s damages resulting from buyer’s default. Thereafter, the amount is presumed to be valid if it does not exceed 6% of the purchase price, unless the buyer can prove it was unreasonable. AB 2020 contemplated that this allowance for certain larger projects would sunset and became inoperative on July 1, 2014 and repealed as of January 1, 2015. To date, no legislation has been passed extending these dates or making this provision permanent.
On July 1, 2014, this temporary exception becomes inoperative and Section 1675 is restored to a 3% presumption of validity rather than 6% for these certain larger scale projects. Projects involving 10 or more units can still stipulate liquidated damages in excess of 3% of the purchase price, but the seller is required to do an accounting and refund any excess to buyer and runs the risk of challenge as to enforceability. We will be following this matter to see if any legislation extends the operation of this temporary provision. If this special allowance for larger scale developments is not extended, affected parties should be aware and account for this in their purchase contracts.
The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient. Readers should consult with legal counsel before relying on any of the information contained herein. Reuben, Junius & Rose 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, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.