It is not unusual for sellers of real estate to want the buyer's deposit to be non-refundable. Banks selling REO properties routinely insist that deposits be non-refundable. If an attorney is representing the owner in a sale of real estate, you can pretty well count on an insistence that any deposits be non-refundable.

In California, though, characterizing a deposit as "non-refundable" does not necessarily make it so. This is the lesson of a recent California Appellate decision (Kuish v. Smith, 4th Appellate District), and it is something of which agents and their clients should be aware.

In December of 2005, Mr. Kuish made an offer to buy the Smiths' Laguna Beach home. Nine counteroffers later the parties reached an agreement on a purchase price of $14 million. Included in the agreement was a requirement that the buyer make two "non-refundable" deposits: one at the opening of escrow and to be released "upon approval of contingencies on or before February 12. The second deposit was to remain in escrow. Escrow was to close on or before July 28.

Over the next few weeks there were escrow amendments regarding both the deposit amounts and the closing date. The results of those modifications were that the deposit amounts would total $620,000: the first one being for $420,000, and the second $200,000. Escrow was extended to August 10, and then again until September 15. Both deposits were made, and, by agreement, $400,000 was released, with the remaining $220,000 staying in the escrow account. Subsequently, the buyer had a change of heart and on Sept. 18 requested that escrow be cancelled. Cancellation instructions were signed by both parties on October 17.

The sellers then sold the property to a backup offer for a price of $15 million ($1 million more than the cancelled transaction). They closed on November 16. The sellers refused to return any of the deposit money, or to allow escrow to release any, to the first buyer, Mr. Kuish. Naturally, Mr. Kuish sued.

The trial court ruled in favor of the sellers. The court concluded that it was the buyer who had breached the contract, and that the seller's retention of the money did not constitute an unreasonable forfeiture. The trial court said that "both parties were 'big boys', that is, sophisticated business people [who] understood all the ramifications of their actions in freely negotiating to make the deposits non-refundable." Mr. Kuish appealed.

The appellate court reversed the decision of the trial court and ordered that the deposits be returned. First the appellate court looked to California Civil Code #3307 which lays out the basis for determining damages when an agreement to purchase real estate has been breached. "The seller's main measure of damages is essentially the difference between the contract price and the property's value at the time of breach." Hence, in a rising market, as this one obviously was, there were no damages to the seller. Moreover, the court also noted that #3294 of the Civil Code expresses "the policy of the law against the allowance of exemplary damages for breach of contract regardless of the nature of the breach". "Any provision by which money or property would be forfeited without regard to the actual damage suffered would be an unenforceable penalty."

The court observed that the parties could have agreed to a liquidated damages clause, but they did not. A liquidated damages clause is a 'pre-agreement' that stipulates that a breach will result in a certain amount of damages. Such clauses, with certain limitations, are perfectly acceptable in California real estate purchase agreements, but they must be signed separately by both parties. Neither the Smiths nor Kuish chose to do so. As a result, the Smiths were only entitled to actual damages, and there were none.

The California Real Estate Purchase Agreement contains a pre-printed liquidated damages clause which buyer and seller may sign if they agree. If sellers want the deposit to be "non-refundable", that is what they should look to.

Published: April 6, 2010

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Bob Hunt is a former director of the National Association of Realtors and is author of the recently published book, "Real Estate the Ethical Way." A graduate of Princeton with a master's degree from UCLA in philosophy, Hunt has served as a U.S. Marine, Realtor association president in South Orange County, and director of the California Association of Realtors, and is an award-winning Realtor. Contact Bob at .