After more than a decade of rising housing prices and a similarly robust market for commercial properties during the last five years, it is sobering to accept that a real estate market downturn is in full swing.Sales volumes are at 20-year lows.The disarray in financial markets is now causing a downturn in commercial real estate as well.Logic and experience tell us that breaches and defaults of property purchase agreements are likely to become more prevalent given todays declining markets compounded by tight credit.Hence, a renewed look at the legal and equitable remedies available to sellers and buyers of real property in failed transactions is timely.
Seller Remedy:Breach of Contract Damages
While the money damages remedy for a seller generally is not favorable in a stable or rising market, it may be advantageous in a declining market.Under the California Civil Code, a sellers measure of damages for breach is the difference between the contract price and the value of the property to the seller on the date of, plus consequential damages and interest.
Recovery of damages usually requires reasonably diligent efforts to resell.If the property is resold before trial at a profit, the seller would recover no actual damages for breach.But in the case of todays declining market conditions, the damages remedy could become a viable option.
Seller Remedy:Liquidated Damages
Because the money damages remedy is not usually advantageous in a stable or rising market, sellers routinely rely on liquidated damages provisions to compensate for a buyers breach.Liquidated damages are a fixed amount defined in the purchase agreement.In theory, upon the purchasers breach, the seller automatically is entitled to recover the liquidated damages, even when the actual damages remedy would result in little or no recovery.
On the other hand, when a purchase agreement includes a provision for the sellers liquidated damages, the seller is precluded from recovering actual damages for a breach.Thus, in a declining market, sellers should give careful consideration before routinely employing a liquidated damages clause in a real estate sale contract since the contractual liquidated damages may only be a fraction of the potential decline in value.
Buyer Remedies in a Declining Market
The damages available to a buyer in the event of a sellers breach also are affected by market conditions.If the seller breaches his promise to convey the real property, the buyers damages include (among other things) the difference between the contract price and the value of the property at the time of breach.In a declining market these damages are usually zero, while in a rising market, they can be significant.
While liquidated damages are theoretically available to buyers, they are rarely provided for in a real estate purchase agreement.However, in todays declining market, a buyer might benefit from a liquidated damages clause, recoverable in the event of the sellers default, even when actual damages are zero.
Specific Performance
In light of the aforementioned limitations and impact of market conditions on the measure and recoverability of actual and liquidated damages, sellers should now consider the equitable remedy of specific performance, usually employed by buyers in a rising market.The primary down side to the sellers specific performance remedy is that the seller must refrain from attempting to sell the property while the lawsuit is pending in order to establish that the seller is ready, willing, and able to perform once the buyer is ordered to complete the purchase.
Election of Remedies Considerations
The law generally allows the non-breaching party to pursue alternative remedies in the same legal action, pleading them in the alternative.Often, a non-breaching buyer does not have to elect between the available remedies until after the verdict, before the judgment is entered.However, a seller has less flexibility, requiring them to make choices among available remedies early in the process after (and sometimes even before) the buyers breach.
Choosing the Right Remedy
The recent reversal in market conditions, from increasing to decreasing real estate values, means that the most appropriate remedy for breach of real property purchase and sale agreements has changed as well.Careful analysis of available remedies is critical at the time of contracting and at the time a legal action may be required to maximize the recovery of the non-defaulting party and/or to defend an alleged defaulting party against excessive and inappropriate relief.
Rutter Hobbs & Davidoff Incorporated