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KASS: Contract’s liquidated damages clause explained

Q:     The contract I just signed to purchase a house contained the following language: “If the buyer defaults, the earnest money will be forfeited to the seller. This is to be considered liquidated damages and not as a penalty.” Can you please explain what this means? Beth.


A:     Shame on you, Beth, for signing a contract without fully understanding what it means. It could have required that your car and your current pension plans be given to the seller if you did not go to closing (escrow). (Just kidding, but stranger things have happened when people sign something they don’t understand).

In your case, should you not be able to finalize the deal, you will have to forfeit (i.e., lose) the earnest money you posted when you initially signed the sales contract. But the law is clear that if the amount you are forfeiting is not consistent with what the seller may have lost because you did not go to closing – but instead is really a penalty – the law will not allow you to lose your deposit.

So lawyers put in the language you question about to protect the sellers.

However, that does not mean you will lose your deposit, if you can prove that the money is disproportionate to the actual loss that your seller may face.

Oversimplified, the damages will be accepted as “liquidated” if the seller cannot really anticipate what the losses will be should you default. Accordingly, it is typical for that language to appear in real estate contracts.

So, for my buyer readers, try to post as little of a deposit as possible; and for my seller clients, try to get as large a deposit as possible.

Hopefully, you will eventually split the difference. And of course, this is completely academic if the buyer closes the deal.


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Q:     I am in this situation where my ex-wife is still on my mortgage but claims she is unable to refinance on her own, due to the debt. I’ve been paying on time for almost 10 years now and we do have a signed divorce decree awarding me the property as well as quit claim deed. You mentioned in the article that you spoke with some banks that would consider 12 months of provable payments and not hold the debt against the other party seeking a new loan. Could you tell me who some of those lenders are? I’d like to reach out to them. Thank you, Gabriel.


A:     Gabriel, I do not refer – or even provide – names of any one. I don’t think it is appropriate to provide any publicity (good or bad) to any company.

Your email, however, leaves me completely confused. You indicate that your divorce decree awarded you the property. If that’s the case, why is it necessary for your ex-wife to be concerned about refinancing?

If you want her to keep the house – despite the divorce court order – that’s your decision. But you will probably need to have that order modified, so that clear title can be in her name.

You have two alternatives: (1) have your ex comply with the court order and transfer the property to you. She will still be on the mortgage unless you are able to refinance and have her released. You can, of course, allow her to stay in the property, if for example there are children who are living there. She can pay you rent – or not – as you see fit.

Or (2) transfer the property to her, but you will still be on the mortgage.

There are some lenders who will agree to release a divorcing spouse from the mortgage obligation; but from my experience there are not too many of such lenders.

The better approach – although both parties generally do not agree – is to sell the house and divide the sales proceeds (if any) pursuant to the divorce decree.


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