Liquidated damages clauses specify in advance, within most standard real estate purchase contracts, how much money is recovered in case of default (that is, when a “promise of performance” has not been attained). Such provisions assure that either the buyer or seller receives money in the event of a breach of some aspect of the legal agreement by the other party.

The liquidated damages provisions in real estate contracts generally cover four major points:

1. The amount of damage money is “specified”
2. The amount of damage money is “reasonable”
3. The damage is “uncertain” or “difficult to ascertain or quantify”
4. The amount of money is directly related to the amount of actual damages

If these four points are improperly stated, then the liquidated damages provision could be voided—thus, unable to be carried out as a benefit to the injured party.

 1   “Specify” the Amount

The provision for liquidated damages will “specify” the payment of a certain amount of money depending on the specific nature of the problem. Therefore, both the buyer and the seller must agree, before the transaction is signed, as to how much money will be awarded to one party, if the other party violates the terms without good cause.

Since the amount of money recoverable is determined before the actual contract is completed, it is only an estimated amount of the actual damages.

An example of a specific amount paid for liquidated damages could relate to the construction of a home. A real estate contract, for instance, might state that if the builder of the house does not complete it by a certain specified date, then the builder will pay $150 per day until the home is completed.

 2   “Reasonable” Compensation

The use of a liquidated damages provision is meant to represent “fair and reasonable” compensation to a wronged party. Thus, it is used to define and limit how much money a harmed party may recover in the event of a reasonable violation of a real estate contract.

The American Law Reports, which is a resource used by lawyers in legal research, states the following on liquidated damages: “Damages for breach by either party may be liquidated in the agreement but only at an amount that is reasonable in light of the anticipated or actual harm caused by the breach…. A term fixing unreasonably large liquidated damages is unenforceable on grounds of public policy as a penalty.”

 3   “Difficult-to-Ascertain” Damage

The liquidated damages provision furnishes a payment of a fair and specified amount of money to compensate for losses in which actual damages are “uncertain” or “difficult to ascertain or quantify.” In addition, if the contract is breached, the liquidated damages can be used when it is difficult to determine or reach another solution to the problem.

 4   Money Amount equals Damages Amount

The amount of money issued in the case of liquidated damages will directly parallel the actual amount of damages incurred by the injured party. Since in many cases it may be impossible to determine the actual amount of damages, the stated money amount is the best estimate of the actual amount of damages.

The amount of money, however, should never serve as a penalty against the defaulting party. A penalty, in real estate law, is defined as being disproportionate (oftentimes excessive) to the actual damages incurred, and serves primarily as a punishment against the faulting party. Liquidated damages, on the other hand, are estimated amounts geared to approximate the extent of the damage that occurs (thus, are proportionate) when the contract is breached.

Earnest Money

For buyers in a real estate purchase contract, the liquidated damages provision will limit their loss, usually to a small deposit of “earnest money.”

For sellers, on the other hand, the provision guarantees them a preset amount of money (again, usually the buyer’s deposit money) in a reasonable, fair, and timely manner, if the buyer defaults. Thus, a liquidated damages provision states the seller has the legal right to keep the buyer’s earnest money if the buyer defaults on the agreement.

Court of Law

When such liquidated damages provisions are not included, or included improperly, in real estate contracts, the amount of money used to compensate a harmed party for a breach by the other party is often determined by a court of law. Thus, one party must sue the other party to recover any actual, provable damages or, in some cases, to force the buyer to purchase the property even though they have decided against such action. This action can be timely, costly, and sometimes difficult to do. It is prudent, therefore, to include a liquidated damages provision in real estate contracts.

Additional Resources

-- American Law Reports: http://west.thomson.com/products/books-cds/alr/default.aspx

-- West’s Encyclopedia of American Law (Enotes): http://www.enotes.com/wests-law-encyclopedia/liquidated-damages

-- RealEstateWords: http://www.realestatewords.com/