Danger: When Keeping Any of a Cash Deposit and Terminating the Contract

Assume a standard California real estate purchase and sale agreement, either residential or commercial, where the buyer deposits 3% into escrow as a deposit, has a period of time to perform inspections and arrange financing, does so, a dispute arises over a small repair item for which the buyer wants a price reduction or credit and which the seller rejects, and at the close of escrow, buyer tenders its lender’s loan proceeds plus the buyer’s own share of the purchase price, minus the rejected repair credit. What should be the advice of the seller’s sales agent, broker, or attorney?

The seller can declare a breach of the contract for failure to deliver the full purchase price on time. Now what? If the liquidated damages provision has been initialed by both sides, then the seller is entitled to the 3% deposit as liquidated damages. Does the seller authorize release of the funds in escrow back to the lender and buyer, minus the 3% deposit? Is the seller required to release all of the deposit and then sue for the 3% deposit and have to collect it after judgment? If there is no liquidated damages provision and the selling price of the property has fallen below the contract price, can the seller require that the difference be retained in escrow pending trial?

The recent Ventura County case of Gould v Corinthian Colleges, Inc. says no. Gould leased a building to Corinthian for a term of six years with a buy-out provision after two years which provided for six months notice of the early termination and payment of $136,500.00 when the notice of early termination was delivered and another payment of the same amount on the date of termination. Corinthian exercised the early termination option and delivered the first payment, but on the date of termination it sent the $136,500.00 minus $16,442.90 from the security deposit, stating in its cover letter that it was doing so. The landlord wrote back that the lease termination provision had been breached by the tenant, the lease remained in full force and effect for the remainder of the lease term, and that since the tenant had vacated and set up operations in another location, that the landlord would hold onto the lease termination payment until it relet the premises, determined its actual damages, and then would return any portion of the funds that was not owed to landlord for unpaid rent and costs of repairing damage to the premises.

The trial court and all three justices of the Court of Appeal held that the landlord waived any shortage or defect in the lease termination payment by failing to return all of the lease termination payment to the tenant. The opinion includes no reasoned discussion of the landlord’s claim of offset for damages for lost future rents and damage to the premises. The decision states:

“Gould argues that he is applying the early termination payments to rent that became due after the November 30, 2005, early termination date. But he cites no authority giving him the right to apply the early termination payment for any other purpose.”

Applying the same reasoning to the purchase and sale hypothetical above, if the seller failed to authorize the escrow to release any portion of the buyer’s funds in escrow, even just the 3% liquidated damages amount, the seller would be deemed to have waived the shortage in the amount to be paid entitling the buyer to specific performance at the lower amount of the contract price minus the previously rejected repair credit.

What about partial rent payments and partial loan payments? Leases and loan documents all reserve the landlord’s and lender’s rights to retain the partial payment without waiving the default. Under this decision, you could keep the money and require that the tenant or borrower pay the missing amount, but you could not initiate an eviction or foreclosure unless you promptly returned either that short payment or a future one.

The rule of this case is that if you want to stand on your rights as a result of a short, late, or otherwise defective payment, you must return the defective payment or risk having the defect deemed waived by your retaining the defective payment.

Should any of these problems arise in any of your transactions, please call me to analyze the best course of action for you or your client.