Caution -- what you say in a proposal may make it binding.

REAL ESTATE CASE OF THE MONTH –WATCH YOUR LANGUAGE.

Two sides seeking to negotiate a lease option contract sign a document explicitly entitled “Final Proposal” which states clearly that its terms “are hereby accepted by the parties subject only to approval of the terms and conditions of a formal agreement.”   Where a formal agreement is never approved by the parties, can this be a binding contract?

Yes.  In First National Mortgage Company, v.  Federal Realty Investment Trust, 631 F.3d 1058, 1065 (9th Cir. 2011) the Ninth Circuit applying California law affirmed a $15 million breach of lease jury verdict finding the existence of a binding contract in precisely the above situation.  The Court distinguished another case holding no binding contract where the document was entitled “letter of intent” and specifically provided that “this letter of intent is of no binding effect.”

The lesson is that it is not enough to state that a contract is conditioned upon the approval of the terms and conditions by way of a formal agreement.  An informal agreement, but an agreement nonetheless, may be found to exist.  If a party wishes to make plain that contractual language is not meant to be binding, the party should state that plainly in the document. 

The Court observed “calling something a ‘proposal,’ instead of a ‘contract’ or a ‘lease,’ does not necessarily mean it was not meant to be binding, especially where the circumstances suggest otherwise.”   In other words, the language of an ambiguous document together with the circumstances surrounding its creation may allow the finder of fact to determine a contract has been formed.

Seller's Broker Beware

Caveat Seller’s Broker. Holmes v. Summer, 188 Cal. App. 4th 1510, 116 Cal. Rptr. 3d 419 (4th Dist. 2010).

In a shocking decision which should cause selling agents concern, a California Court of Appeal has held that a selling agent owes a duty to disclose to a buyer, even before escrow, that there is a substantial risk that the seller could not transfer title free and clear of monetary liens and encumbrances.

The decision is surprising on several levels. First, a selling agent does not normally owe a fiduciary duty to the buyer, but only to his client, the seller. The Holmes Court glided over this point stating that “although the seller's agent does not generally owe a fiduciary duty to the buyer, he or she nonetheless owes the buyer the affirmative duties of care, honesty, good faith, fair dealing and disclosure. . . as well as such other nonfiduciary duties as are otherwise imposed by law.”

The Holmes Court found that the broker should have disclosed to the buyer what the broker knew: that the property was so over-encumbered that it could not be sold unless the lenders agreed to a short-sale or the seller deposited close to $400,000 in cash into escrow to cover the shortfall. Holmes seems to create a new quasi-fiduciary duty for a selling agent, maybe not of the highest good faith, honesty and fair dealing, but still a duty disclose known conditions or risks with the property directly to the buyer, who is not the selling agent’s client. The Court held: “At a minimum, the brokers did not act fairly towards these residential buyers when signing them up for a real estate deal the brokers had reason to know was a highly risky proposition.”

The new non-fiduciary duty to disclose in Holmes arose before the buyer and seller even entered into a contract. One might wonder if a selling agent is now required before escrow to disclose possible matters about a house such as: problems with the neighborhood; a history of roof leaks; defective construction; earthquake damage; or other facts that could be material to a purchase decision. The current convention is that such disclosures are made after the purchase contract is signed and during escrow. Selling agents would be wise to consider how and when they make disclosures, and now to consult counsel.

The buyers in Holmes could have discovered quite easily on their own that the house they were buying was underwater simply by checking title or having their own broker pull a preliminary title report. The recorded deeds of trust were a matter of public record. The California Association of Realtors form used in Holmes required disclosures about title within seven days of opening escrow. And so what if the buyer learns a week into escrow about the precariousness of the seller’s ability to convey title at the agreed purchase price? The seller presumably can cure this condition. The buyer retains the right to cancel escrow if good title could not be conveyed by closing.

Holmes fails to consider the implications of a rule that requires pre-escrow and pre-contract disclosure of matters known to the seller that a reasonable investigation would identify. Holmes means that sellers and their agents must disclose matters that buyers could discover on their own, if the information is sufficiently material that, but for the nondisclosure, the buyer might not have made the offer.

A seller can sue for specific performance, even if the liquidated damages clause is initialed under the CAR form contract.

“Don’t worry,” the broker told the remorseful buyer, who realized the day before the long escrow was set to close that the fair market value of the Property was now 25% less than the contract price of $4,000,000. The parties had signed and initialed the liquidated damages clause in the standard California Association of Realtors form. “If you back out now, you will only you lose your deposit actually paid.”

The common California Association of Realtor liquidated damages provision states in bolded, large print: “LIQUIDATED DAMAGES: If Buyer fails to complete this purchase because of Buyer’s default, Seller shall retain as liquidated damages, the deposit actually paid. If the Property is a dwelling with no more than four units, one of which Buyer intends to occupy, then the amount retained shall be no more than 3% of the purchase price. Any excess shall be returned to Buyer. Release of funds will require mutual, Signed release instructions from both Buyer and Seller, judicial decision or arbitration award.” (Emphasis added.)

Imagine a case where the buyer backs out unjustifiably and the seller feels strongly that 3% does not begin to fairly address the seller’s true injury. Does this clause mean that the seller’s only remedy if the buyer defaults is to take the liquidated damages, which in the usual case is less than 3% of the purchase price?

No. “[A] liquidated damages provision does not deprive the seller of his or her election to seek specific performance.” 1 Witkin, Sum. of Cal. Law, Contracts § 544, p. 590 (10th ed. 2005) (citing to Civ. Code §§ 1680 and 3389). Civil Code section 3389 provides:

Contracts Providing for Penalty or Liquidated Damages. A contract otherwise proper to be specifically enforced, may be thus enforced, though a penalty is imposed, or the damages are liquidated for its breach, and the party in default is willing to pay the same.

Civil Code section 1680 states:

Right to Specific Performance Not Affected. Nothing in this chapter [which is entitled “Chapter 2, Default on Real Property Contracts”] affects any right a party to a contract may have to obtain specific performance.

In 1977, the Law Revision Commission Comment to Civil Code section 1680 reiterated this principle and made clear that Section 1680 had no effect on Section 3389:

Section 1680 makes clear that this chapter does not affect the rule under existing California law that the right of the seller to obtain specific performance of a contract for the purchase of real property is not affected by the inclusion in the contract of a provision liquidating the damages to the seller if the buyer defaults on his agreement to purchase the property. See, Section 3389, People v. Ocean Shore R.R., 90 Cal. App. 2d 464, 203 P. 2d 579 (1949), and other cases interpreting Section 3389.

[Emphasis added.]

Justice William Masterson (Retired), Justice Elizabeth Baron (Retired), Louise LaMothe, Esq. explain this notion in detail in the California Civil Practice Business Litigation Manual at § 33:7 (2006):

A contract otherwise proper to be specifically enforced may be enforced even though a penalty is imposed, or the damages are liquidated for its breach, and the party in default is willing to pay the liquidated damages or penalty. Civ. Code § 3389. The provisions of Civil Code section 3389 do not make a contract specifically enforceable simply because it contains a provision for liquidated damages. The provisions allow a party to waive his or her stipulated damages and maintain an action in equity. Morrison v. Land, 169 Cal. 580, 147 P. 259 (1915). Thus, when a real estate purchase and sale agreement contains a liquidated damages provision, the vendor may nonetheless elect to sue for specific performance.

“When a purchase and sale agreement contains a liquidated damages provision, the seller may nonetheless elect to sue for specific performance.” Allen v. Smith, 94 Cal. App. 4th 1270, 1279, n. 3, 114 Cal. Rptr. 2d 898 (2002) (the standard California Association of Realtors (“CAR”) form agreement with a liquidated damages clause [identical to the one employed here] does not create an option contract but is a purchase agreement, hence a seller can sue for specific enforcement if the buyer fails to perform) (emphasis added); Johnston v. Blanchard, 16 Cal. App. 321, 325-26, 116 P. 973 (1911) (under the provisions of Civil Code section 3389 it is immaterial whether the sum specified in the contract be regarded as liquidated damages or as a penalty, “for in either case the plaintiff had a right to waive an action at law and resort to equity for specific performance”); Ocean Shore, supra, 90 Cal. App. 2d at 470-71, (where stipulation for liquidated damages in case of vendee’s breach of contract to purchase land constitutes security for his performance of contract, specific performance thereof may be had by vendor).

In Glock v. Howard & Wilson Colony Co., 123 Cal. 1, 9, 55 P. 713 (1898), the Supreme Court, in discussing the rule laid down by Section 3389 held:

This declaration was to set at rest a question which somewhat vexed the courts, namely, that, as the parties made their damages certain by stipulation, uncertainty, which alone justified the interposition of equity, was removed, and therefore only redress at law remained. * * * Thus, so far as this State is concerned, the question is concluded by the Code, and a party may either rest satisfied with a recovery of stipulated damages, or waiving them, may resort to equity for specific performance.

(Emphasis added.)

One commentator observes:

It is presumed that the breach of an agreement to transfer real property cannot be adequately relieved by pecuniary compensation. Even a stipulation of the amount of damages in a particular case will not prevent specific performance. Such a stipulation merely gives a party a right to be satisfied with damages, but, waiving them, he or she may resort to equity for specific performance.

58 Cal. Jur. 3d, Specific Performance, § 47, pp. 81-82 (2004).

Examples of cases where vendors were found to be entitled to seek specific performance in the event of a breach of contract, with a liquidated damages clause in the agreement, include: Morrison, supra, 169 Cal. at 589 (a party may waive the right to liquidated damages and maintain an action in equity); Kirch v. Wattell, 40 Cal. App. 501, 502, 181 P. 111 (1919) (plaintiff is not required to accept liquidated damages as set forth in the contract) (“We think that specific performance was the appropriate remedy and that plaintiff was not required to resort to an action for damages as her only means of obtaining satisfaction of the obligations assumed by defendant.”); Johnston, supra, 16 Cal. App. at 325-26 (where defendant sold his business and covenanted not to engage therein in the same district for 30 years, and that he should forfeit to the purchaser the sum of $5,000 as liquidated damages for a violation of this agreement, the purchaser was entitled to seek specific enforcement of the agreement under Section 3389).

Courts have allowed a plaintiff-seller to sue to recover the contract purchase price where a defendant-buyer was in breach of an agreement containing a liquidated damages clause. For instance, in Burg Bros. v. Bercut, 73 Cal. App. 114, 138 P. 166 (1925), the plaintiff-seller and defendant-buyer entered into several agreements to purchase land. After the buyer breached the agreements by failing to make payments for the land, the seller brought suit for damages in addition to those included within the liquidated damages provision contained in the purchase and sale agreement. Id. at 117. The liquidated damages provision in Burg stated:

In the event of a failure of the buyer to comply with any of the terms or conditions of this agreement, and the continuance of such failure for a period of 60 days after performance, the seller shall be released from all obligations in law or in equity to transfer and convey said property, or any part thereof, and the buyer shall forfeit all rights under this agreement, and all rights to any and all moneys which he shall theretofore have paid hereunder, and said moneys shall be applied as rent for the use of said premises, and as liquidated damages and expenses occasioned by such default, and not as penalty.

Id.

The buyer argued that the agreements were merely an option to purchase, and not agreements for the purchase and sale of the property. Id. The court disagreed and held that the liquidated damages clause in the agreements did not deprive the seller/vendor of the right, granted by law, to stand upon the contract and sue to enforce its performance when the buyer/vendee defaulted in making payments. Id., at 118. The court further ruled that the principle established in California does not restrict a vendor’s right of election of remedies despite the inclusion of the liquidated damages clause, and upon the vendee’s default the vendor might still treat the contract as being in force and sue for and recover the balance of the purchase price. Id., at 119-20.

Similarly, in Royer v. Carter, 37 Cal. 2d 544, 547, 550, 233 P. 2d 539 (1951), the Court held that where the contract for sale of realty provided a liquidated damages provision that amount paid could be retained at option of vendor upon default of purchaser as consideration for execution of agreement, retention by vendor of the down payment upon default by purchaser was not inconsistent with the vendor’s right to elect to hold purchaser responsible for actual damages. In Royer, the defendant-purchaser agreed to by plaintiff-vendor’s house and lot for $24,000 and paid $1,000 as a down payment. Id., at 546. Because the purchaser was unable to secure the funds for the remainder of the payment, the purchaser defaulted on the contract and the plaintiff put the home back on the market. Id. The plaintiff was able to resell the property for $18,500. Thus, the plaintiff did not need to seek specific performance in the trial court, but sought to recover damages.

When the plaintiff sued for damages, the trial court awarded the plaintiff damages equal to the difference between the contract price and the price at which the property was resold plus the expenses incurred in connection with the first sale, but less the amount of the down payment. Id. The agreement in Royer contained a liquidated damages clause that stated: “That should the purchaser fail to pay the balance of the purchase price, or fail to complete the purchase, as herein provided, the amounts paid hereon may, at the option of the seller, be retained as the consideration for the execution of this agreement by the seller.” 37 Cal. 2d at 546-47.

The Court remanded reversing the trial court only on the issue of the calculation of damages, which should have been the difference between the contract price and the fair market value of the property at the time of the breach. Id., at 550-551. The defendant-purchaser argued on appeal that the provision gave the plaintiff-seller the option to either keep the $1,000 as damages or file suit for damages, and because the plaintiff-seller kept the down payment, she was prevented from seeking any other damages. Id., at 547. The Court disagreed, holding that independently of any rights the plaintiff may have had under the liquidated damage clause, the plaintiff had the alternative right to retain the down payment as a set off against her actual damages. Id.; see also, Gattuccio v. Kallam, 153 Cal. App. 2d 55, 57, 314 P. 2d 178 (1957) (“since the actual damages were found to exceed the. . . [liquidated damages] deposit, [the plaintiff] respondent. . . was entitled to it as a set-off whether the agreement was a valid one for liquidated damages or not”).

Allen v. Smith, 94 Cal. App. 4th 1270, 114 Cal. Rptr. 2d 898 (2002) is instructive. There, the defendant-sellers and the plaintiff-buyer entered into a real estate deal using a standard form published by the California Association of Realtors entitled “Residential Purchase Agreement (and Receipt for Deposit).” Id. at 1275. The agreement included the standard California Association of Realtor liquidated damages clause.

The plaintiff-buyer paid the initial deposit of $20,000 into escrow, and, after releasing all contingencies, paid an additional $80,000 deposit into escrow. Id., at 1276. The escrow company immediately released the $100,000 to the defendant-sellers. Id.

Thereafter, the plaintiff-buyer notified the sellers she would not complete the purchase. Id. The plaintiff-buyer conceded the defendant-sellers were entitled to retain her initial $20,000 as liquidated damages, but the plaintiff-buyer demanded that defendant-sellers refund the $80,000 additional deposit on the ground the parties had not signed a separate liquidated damages provision covering the increased deposit as required by statute. Id. The defendant-sellers refused to give the plaintiff-buyer a refund and the plaintiff-buyer sued for the defendant-sellers for breach of contract, money had and received, conversion, fraud and specific performance. Id.

The defendant-sellers did not file a cross-complaint or sue for specific performance. They defended their retention of the $100,000 arguing that they were entitled to keep that amount because it represented an option payment under the liquidated damages clause (even though it was some $46,750 more than $53,250, namely the 3% of the purchase price that the liquidated damages clause would allow). Id., at 1281. After both parties moved for summary judgment, the trial court ruled (incorrectly) that the California Association of Realtors form agreement was a mere option for sale and ruled in favor of the defendant-sellers. Allen, 94 Cal. App. 4th at 1276. The plaintiff-buyer appealed. The Court of Appeal reversed, holding that the defendant-sellers must return $46,750 to the buyer-seller. Id., at 1279-81.

After a detailed discussion about the adequacy of liquidated damages generally, the Court stated:

“We conclude that the parties intended to enter into a purchase and sale agreement and not an option. The contract consists of a California Association of Realtors standard form deposit receipt and counteroffer. These forms ordinarily constitute a binding and enforceable contract for the purchase and sale of the described property. [Citations omitted]. A legitimate option ordinarily consists of an agreement to grant an irrevocable right to purchase for independent consideration, and a separate purchase and sale agreement attached as an exhibit thereto. [Citations omitted].”

Id., at 1279-80.

Central to the Court’s reasoning that the California Association of Realtors form contract cannot be construed as an option contract was its observation: “When a purchase and sale agreement contains a liquidated damages provision, the seller may nonetheless elect to sue for specific performance.” Id., at 1279-80, n. 3 (Emphasis added.) If this reasoning were not true, then the California Association of Realtors form could be unilaterally cancelled by the buyer at anytime without the consent of the seller. This would render the form no more than an option contract, which is what Respondent is essentially and erroneously arguing in this case, and which is also what the Court rejected in Allen, supra. See also, Meyer v. Benko, 55 Cal. App. 3d 937, 944, 127 Cal. Rptr. 846 (1976) (holding that a C.A.R. form deposit receipt signed by the parties was an enforceable contract of sale and not merely an offer subject to various contingencies); Mattei v. Hopper, 51 Cal. 2d 119, 122, 330 P.2d 625 (1958) (written agreement on a form supplied by the real estate agent found to be an enforceable and binding contract).

The California Association of Realtors has published an article entitled “Liquidated Damages and Deposit Forfeitures” which explains the meaning of the relevant contract language. This article states in pertinent part:

“Q 12. If a buyer and seller agree to a liquidated damages clause, are the seller’s remedies limited to pursuing liquidated damages, or could the seller pursue other legal remedies such as specific performance? [Emphasis in the original.]

A. Monetary damages represent only one type of legal remedy available to a seller. The types of legal remedies that a seller can pursue when a buyer breaches a contract, including specific performance (a type of legal action to compel a party to a contract to complete his or her performance under the contract). Typically, a liquidated damages clause only limits the amount of monetary damages a seller can collect as compensation for a buyer’s breach of contract, it does not prevent the seller from pursuing an action for specific performance.”

“Q 13. The previous question suggests that sellers can often choose from amongst various legal remedies when a buyer defaults. Which is the best legal remedy? [Emphasis in the original.]

A. Choosing an appropriate legal remedy usually depends on many different factors, including extent of one’s injury, the complexity of pursuing a particular remedy, and potential legal costs. For example, an action for specific performance, to compel a buyer to complete his or her contract obligations, is generally much more complex than an action to recover liquidated damages and is more difficult to win, and may be more costly than an action to recover liquidated damages. A seller who is interested in exploring the benefits and detriments associated with different legal associated with different legal remedies generally should consult an attorney.”

Thus, while the language of the standard California Association of Realtors may at first glance seem to lend itself to the argument that the Seller shall accept liquidated damages, the Buyer is not barred from seeking or recovering specific performance or other relief in equity, pursuant to controlling authorities including Civ. Code §§ 1680 and 3389 and decisional law. The Seller, in the appropriate case, may elect to enforce the contract. Accepting money damages under the California Association of Realtors form is not the exclusive remedy.

“While the remedies of specific performance and damages are inconsistent, a party may pray forth for both remedies in the complaint, but it may only recover one of the remedies.” Miller & Starr, Cal. Real Estate, Remedies § 34.17, p. 69 (2001). “[A]n election [about whether to recover money damages for breach of contract or specific performance] must be made before judgment in order to avoid a duplicate recovery.” Id., § 34:3, p. 15.

In principle, there is nothing so odd about a seller suing for specific performance, except as a practical matter, in most years California real estate prices have tended to rise, instead of fall. Sellers have obtained specific performance in many cases. See, e.g., Ellison v. Ventura Port Dist., 80 Cal. App. 3d 574, 579-80, 145 Cal. Rptr. 665 (1978) (“A presumption exists that the remedy at law is inadequate when the contract is for the sale of land.”); Laske v. Lampasona, 89 Cal. App. 2d 284, 287, 200 P. 2d 871 (1948) (“It is not contended that a vendor of real property may not have specific performance of a valid agreement to purchase. It is, of course, well established that he has such right.”); Waratah Oil Co. v. Reward Oil Co., 23 Cal. App. 638, 640-41, 139 P. 91 (1914) (holding that seller could not be denied specific performance simply because the property could be sold on the open market at or near the contract price). “The vendee of a contract to sell land may seek specific performance, and the same remedy is available to the vendor .” 58 Cal. Jur. 3d, Specific Performance, § 59, p. 99 (2004).

For example, in BD Inns v. Pooley, 218 Cal. App. 3d 289, 296, 266 Cal. Rptr 815 (1990), in an action brought by a vendor, the Court affirmed a trial court decision ordering the vendee, an individual, to purchase the vendor’s motel. The Court held that an effective form of judgment for a plaintiff-seller in a specific performance orders the buyer-defendant to purchase the property and provides that, if the buyer-defendant fails to do so within a certain time, a judgment for the purchase price be entered against him. Id.

Similarly, in Landis v. Blomquist, 257 Cal. App. 2d 533, 540, 64 Cal. Rptr. 865 (1967), an action by vendors against a purchaser for specific performance for sale of an apartment building, the trial court rendered a judgment directing the purchaser to pay the vendors the full amount of the purchase price under the contract. The Court affirmed the decree of specific performance, holding that it properly “ordered defendant to pay plaintiffs $152,816.15 [the contract price] plus interest, and upon such payment, directed plaintiffs to convey the property with certain adjustments.” Id.; see also, Goldworthy v. Dobbins, 110 Cal. App. 2d 802, 810-11, 243 P. 2d 883 (1952) (vendees ordered to purchase Los Angeles by lot in action brought by vendor seeking specific performance); Schmidt v. Callero, 97 Cal. App. 2d 582, 218 P. 2d 80 (1950) (court affirmed trial P. 2d 883 (1952) (vendees ordered to purchase Los Angeles by lot in action brought by vendor seeking specific performance); Schmidt v. Callero, 97 Cal. App. 2d 582, 218 P. 2d 80 (1950) (court affirmed trial court decision that vendors entitled to decree of specific performance of purchase of resort property by purchaser); Laske, supra, 89 Cal. App. 2d at 288 (finding that court in equity may order defendant buyer to pay the purchase price and take the deed).

The bottom line is that sellers are not without recourse to sue for specific performance under the standard California Association of Realtors form agreement. Buyers should be forewarned.

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