Does The C.A.R. Contract Reward A Buyer Who Fails To Make Their Initial Deposit?

by David Hamerslough

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Over the past five weeks, I have had six qualified California real estate attorneys ask me this question. Each has expressed concern that ¶ 14.C.2 appears to reward a buyer who doesn’t make their initial deposit. On the other hand, if you ask C.A.R. the same question, their response is that it does not reward the buyer but gives the seller a choice of options in that situation.

The starting point for evaluating this issue is ¶ 14.C.2. It provides the seller with a mechanism to cancel a transaction where the buyer fails to perform a contractual obligation after first issuing a Notice To Perform. One such contractual obligation is to make the initial or increased deposit. It is the last sentence of this paragraph that prompts the questions and issues raised in this article. That sentence reads as follows:

“In such event, seller shall authorize the return of Buyer’s deposit except for fees incurred by Buyer and other expenses already paid by Escrow Holder pursuant to this Agreement prior to Seller’s cancellation.”

According to C.A.R, ¶ 14.C.2 provides a trade-off. The seller has two options. The first is to issue a Notice To Perform and then cancel the contract. If the seller exercises this option, they give up the right to the deposit. When no deposit has been paid, C.A.R.’s position is that since the deposit was never made, no further action is required, even though the buyer arguably breached the contract. C.A.R.’s rationale is that this avoids a dispute over whether the buyer’s breach is material and therefore justifies a cancellation by the seller. This option allows the seller to move on and sell the property without any delay.

The seller’s second option is to do nothing and wait to find out if the buyer closes escrow. If that occurs, then the seller receives the benefit of the buyer’s performance. If it doesn’t occur, the seller can then issue a Demand To Close Escrow and pursue the buyer for damages. Because the deposit has not actually been paid by the buyer, the seller can pursue the buyer for actual damages resulting from the buyer’s wrongful failure to close. This typically would be measured by Civil Code § 3307 and would represent the difference between the contract price and the fair market value of the property on the date of the breach plus consequential damages, interest, attorneys’ fees, and costs. According to C.A.R., option number two arguably applies even if liquidated damages has been initialed, as long as the buyer does not make the deposit. The rationale is that if no deposit is made, the liquidated damages clause is invalid and of no effect.

The reaction I received from the six attorneys I spoke with to C.A.R.’s trade-off was one of astonishment, and they all raised a number of questions and concerns:

• Why should a buyer who defaults in their contractual obligations benefit from that conduct?
• How does C.A.R. reconcile the provisions of ¶ 14.C.2 with the contractual and common-law obligation of a party to a contract to act in good faith?
• Why should the seller have to wait until the proposed close of escrow to resell the property?
• Why should the seller not have any recourse in the event they cancel and then resell the property at a loss?
• What is the impact, if any, if the buyer or seller signs and delivers a cancellation or takes some other action that arguably constitutes a repudiation of the contract?
• Should the outcome of such a dispute turn on which party cancels and/or repudiates first?
• What impact, if any, does a cancellation or other repudiation have on any remaining contractual obligations, including Notices To Perform, Demands To Close Escrow, etc.?
• What is the impact, if any, if the contract is contingent vs. non-contingent or whether liquidated damages has been initialed?
• What are the risks and/or ramifications of communications (e.g., texts, emails, Tweets, etc.) between a buyer or seller and their respective agent and/or between agents for the buyer and seller that discuss making the deposit, canceling, or other subjects related to this type of dispute?
• To what extent should buyers and sellers be consulting with a qualified California real estate attorney before any such communication is made or any cancellation is signed and delivered?
• How do these questions and their answers give rise to any certainty or predictability for resolving disputes of this nature?

My reaction was the same as my colleagues’. In addition, there are a number of other issues that I see with the trade-off that C.A.R. has apparently provided in ¶ 14.C.2. First, it may encourage a buyer to write a “highest and best” winning offer but not make their deposit. That may involve discussions between the buyer and their agent and/or an agent promoting this strategy. An agent who discusses, or promotes, this approach should consider their agency obligation of honest and fair dealing and good faith to all parties in a transaction. They also should consider any fiduciary obligation that might exist in a dual agency. Given the potential issues, an agent may want to recommend that a buyer (and/or seller in a dual agency situation) consult with a qualified California real estate attorney before the agent has these discussions or promotes this strategy.

Second, the trade-off does not fairly weigh the impact on the seller, who has accepted an offer that is typically significantly higher than any other offer. Sellers and their agents may want to reconsider initialing liquidated damages when presented with such an offer, especially in a declining market.

Third, the trade-off requires a seller to wait until the scheduled close of escrow before they can remarket the property if they want to pursue a claim for damages. This delay is of no benefit to a seller when the buyer’s offer was significantly higher than all other offers and/or there is a declining market. Such delay also increases the seller’s carrying costs. All of this places the burden on the seller to accept more of the risk caused by a buyer’s failure to meet their contractual obligations.

Fourth, this trade-off may be impacted by other contractual terms (e.g., contingencies) or actions (e.g., signed and delivered cancellations or other conduct that constitutes a repudiation of the contract). While C.A.R. may acknowledge the potential impact of these actions, my concern is that a party and/or their agent may not fully realize that impact. Consulting with a qualified California real estate attorney before any such actions are taken may be prudent.

Fifth, the potential impact of communications on any of these subjects that may occur between a buyer and/or seller and their agent and between the agents on the outcome of this type of dispute should be considered. The issue may be the potential liability that buyers, sellers, and real estate licensees may unknowingly assume based upon their communications and actions in cancelling or otherwise repudiating a contract.

Sixth, C.A.R.’s trade-off also doesn’t consider that under its contract, the seller has the option of suing for specific performance. While that remedy is rarely pursued to its conclusion for a variety of reasons, will it now be more attractive than the apparent trade-off of ¶ 14.C.2? If specific performance is asserted by a seller, what impact will it have on the parties’ ability to resolve any dispute quickly and predictably?

Finally, the trade-off does not appear to promote certainty and predictability in any dispute regarding these issues; rather, it may encourage buyers to not make their deposit with the expectation that they can do so without any potential liability. It also may result in the parties and their agents seeing if they can bait one of the parties into canceling first so that the non-canceling party can then make an argument in their favor based upon that cancellation.

Does the C.A.R. contract reward a buyer who fails to make their initial deposit? My response is that it may do so; it depends on the facts and circumstances, what actions are taken and what communications are made by the buyer, seller, and their respective agents, and how a judge or arbitrator reconciles what are going to be conflicting facts, legal obligations, etc.

What is of concern to me is that the current version of ¶ 14.C.2 does not appear to promote any certainty and predictability in the resolution of these disputes, which then leads inevitably to litigation between buyers, sellers, and agents. While C.A.R. may have intended to address the situation where a buyer fails to make the deposit, my concern is that the number of variables created by ¶ 14.C.2 may only foster more litigation.

C.A.R. needs to address this situation in its contract. Unfortunately, the June 2022 revision to the C.A.R. Cancellation Agreement may only exacerbate the issues raised by ¶ 14.C.2. Paragraph 2 of the Cancellation Agreement now includes an option that can be checked regarding the disposition of the deposit. This new option is “There is no deposit in escrow.” While that may be a reality on some occasions, will this language cause buyers who fail to pay the deposit (by design or otherwise) and their agents to believe that doing so is consistent with the provisions of ¶ 14.C.2 and therefore without any risk?

Until C.A.R. addresses this issue, buyers, sellers, and agents need to be aware of the issues raised in this article. Sellers should consider consulting with a qualified California real estate attorney to discuss countering the Buyer’s offer on a C.A.R. form with language that could help resolve the questions raised above and specifically review the following language with that attorney:

“The Parties understand, acknowledge and agree that any failure by Buyer to make a timely deposit into escrow of the agreed-upon initial and/or additional deposits shall be deemed to be a material breach of this Agreement and, at Seller’s sole discretion, shall entitle Seller to pursue any and all legal and/or equitable remedies as well as recover any and all damages of any kind, including but not limited to attorneys’ fees and costs, that result from the Buyer’s breach of this Agreement, whether or not the Liquidated Damages provision has been initialed by all Parties.”

Alternatively, the parties could use the PRDS purchase contract.

In any circumstance, the parties should consider consulting with a qualified California real estate attorney before taking any actions or having any communications regarding whether to make the deposit and when or whether to cancel a contract. They should also consider the attorneys’ fees and costs that they will incur in the event that disputes of this nature arise.

About David Hammerslough