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Are Liquidated Damages All Wet?

by Robert S. Kutner - Partner, Casner & Edwards | Feb 28, 2017
Almost every residential real estate agreement in Massachusetts contains a provision describing what will happen if the buyer defaults in the obligation to purchase. Those provisions are often referred to as liquidated damages clauses. These clauses generally state that the seller will retain the buyer’s deposit as their sole remedy.
By limiting the sellers’ recovery to the amount of the deposit, liquidated damages clauses protect the buyer from a claim that may be far larger. For example, a liquidated damage clause prevents a seller from being able to sue a buyer who defaulted if, after the default, the seller is forced to sell the home at significantly reduced price.

The term liquidated damages refers to an agreement by the parties upon an amount which fairly represents the damage reasonably likely to be suffered by the seller in the event that the buyer breaches. It is typically a term in an Offer or in a Purchase and Sale Agreement (P&S), to establish the amount a seller will recover from a buyer upon the buyer’s breach, because of the difficulty or impossibility for the seller to prove the exact amount of damage suffered. Liquidated damages provisions protect sellers by eliminating the requirement that the seller prove the actual damage suffered.

Occasionally, it has been argued by buyers that the loss of their deposit, without proof of actual damages, is unenforceable as a penalty. This argument is raised when the buyer defaults after a P&S has been signed when the deposit has increased to five or
10 percent of the purchase price. This was the issue faced by the Massachusetts Appeals Court in 1999 in Kelly v. Marx.

The Appeals Court refused to enforce a $17,750 liquidated damages clause, despite the buyer's concession that they had breached their agreement to purchase. Ignoring a clear liquidated damages clause, the Appeals Court ruled that the Court should have
taken a second look at the actual loss suffered and should have ruled that the liquidated damages clause amounted to an unenforceable penalty because the seller had not suffered an actual loss.

The Appeals Court decision raised uncertainty, particularly among escrow agents who were unsure how to handle such disputes. The Massachusetts Association of Realtors® stepped in by filing a brief in the further appeal to the Supreme Judicial Court.

On February 10, 1999 the Massachusetts Supreme Judicial Court (SJC) reversed, holding that the liquidated damages clause in a real estate agreement was valid,
despite the lack of any financial loss to the sellers, when the buyers defaulted. After the buyers defaulted, the sellers had sold the home to other buyers for a higher price.

The SJC reversed a contrary decision of the Appeals Court in Kelly v. Marx which had ruled the liquidated damages clause constituted an unenforceable penalty. The SJC held that the reasonableness of a liquidated damages provision should be evaluated based upon the circumstances at the time the contract was made and that the second look doctrine advocated by the Appeals Court in its decision should be rejected.

MAR was successful in getting a bill enacted that protects brokers and others who act as escrow agents. The law allows escrow agents to continue to hold a deposit pending resolution of a dispute between buyer and seller provided that the Offer or P&S expressly authorizes the agent to hold the funds. The law can be found in General Laws Chapter 184, Section 17A.