Often a real estate contract will contain a liquidated damages clause. This is a provision in the agreement stating that, if one party breaches the contract, the other party will recover a pre-set amount of money. For example, it is common for a sales contract to provide that, if the buyer does not go forward with the purchase, the seller may retain the deposit, which the buyer made into escrow, as liquidated damages.
Liquidated damages clauses in California real property purchase contracts are governed by Civil Code Sections 1675 to 1681. To be enforceable, a liquidated damages clause in a real estate purchase contract must meet the following requirements:
(1) The liquidated damages clause in the contract must be separately signed or initialed by both parties. Civil Code Section 1677(a).
(2) If the contract is printed, the liquidated damages must be either: (a) in bold type, at least 10 points large; or (b) in contrasting red ink, at least 8 points large. Civil Code Section 1677(b)
The idea behind liquidated damages clauses is that, in some cases, it would be too difficult or expensive to determine actual damages, so the parties will make a reasonable estimate of actual damages in advance. Thus, liquidated damages will be upheld, only if the amount is reasonable, in the sense of being a reasonable approximation of the actual damages the aggrieved party would be expected to suffer if the other side broke the contract.
In the case of residential real property purchase contracts, liquidated damages are presumed reasonable if they are not more than 3% of the total purchase price. They are presumed to be unreasonable, if they are more than 3% of the total purchase price. Civil Code Section 1675(c). The presumptions are not conclusive; it is possible to introduce evidence in court to contest them. This presumption does not apply in commercial real estate deals.