Arbitration and Liquidated Damages Clauses

23 Jan Arbitration and Liquidated Damages Clauses

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Since mediation, arbitration and liquidated damages clauses generally pertain to situations where a dispute and/or a possible a default has arisen, it is worth noting that once money is deposited into escrow, it is not released except by the signed mutual instructions of both buyer and seller, a court order or a decision pursuant to binding arbitration. Whatever happens, no matter how clearly one side sees the rights or wrongs of a situation, money in escrow will not be released to either party except in those three circumstances.

Mediation and Arbitration – Many real property sale and purchase contracts contain optional or mandatory mediation and/or arbitration provisions.

Despite efforts that may be made to avoid them, disputes can sometimes arise in connection with real property sale and purchase transactions. If a dispute involves a significant issue and the parties are unwilling to come to an agreement concerning how it should be resolved, the filing of a lawsuit may seem to be the only remedy available.

In order to provide buyers and sellers of real property with a less formalized and often less costly form of dispute resolution, many real property sale and purchase contracts contain optional or mandatory mediation and/or arbitration provisions. Mandatory mediation clauses often provide that if a party fails or refuses to mediate, that party loses the right to later obtain its attorney’s fees in an arbitration or court proceeding. Only a qualified attorney is competent to give legal advice regarding the advantages and disadvantages of mediation and arbitration.

Mediation is a non-binding process by which the parties to a dispute come together with a professionally trained and experienced mediator who assists them in attempting to resolve their dispute by negotiating a mutually acceptable settlement. The result of a successful mediation is a written settlement agreement which, when properly prepared and signed by all the parties to the dispute, should be legally enforceable. The settlement agreement is a document that should be reviewed by a qualified real estate attorney since its scope can affect important legal rights. If mediation is unsuccessful, the parties are left to pursue other forms of dispute resolution, such as arbitration or litigation.

The cost of mediation can vary depending on the mediator selected and the amount of time allocated for the mediation. Mediation fees can be as little as a few hundred dollars, divided equally between the parties, or they can involve an initial filing fee of several hundred dollars plus a substantial hourly fee for the mediator.

Arbitration is a binding process by which the parties to a dispute (either by themselves or through their attorneys) submit the dispute to a neutral arbitrator for resolution. A binding agreement to submit disputes to arbitration is effected when both the buyer and the seller initial the “Arbitration of Disputes” provision contained in most residential real property sale and purchase contracts. By agreeing to arbitrate disputes, the parties give up their right to have the dispute litigated in a court of law before a jury. Once the decision of an arbitrator is rendered, it generally is not appealable and is immediately subject to full legal enforcement.

The disputes subject to arbitration include only those arising out of matters described in the “Arbitration of Disputes” provision of the residential purchase contract. Further, under most purchase contracts, the brokers are not obligated to arbitrate any of these described matters. Buyers and sellers should read this provision carefully to determine which types of actions are included. Buyers and sellers are urged to consult with a qualified real estate attorney before initialing the “Arbitration of Disputes” provision of any purchase contract. The legal profession is divided concerning the relative merits of a jury trial as opposed to alternative forms of dispute resolution, such as arbitration. Buyers and sellers are urged to give careful consideration to the consequences of giving up their rights to a jury trial before electing to arbitrate instead.

In San Francisco, the majority of purchase contracts do include an Arbitration clause, incorporated by the agreement of buyer and seller.

Note: Small Claims Court actions (as of this writing, up to $10,000) are exempt from Arbitration under the clause in the standard San Francisco contract.

Liquidated Damages – Most residential real property sale and purchase contracts contain liquidated damages clauses which, if initialed, set the maximum amount of damages a seller may recover if the residential real property sale and purchase contract is breached. In San Francisco, this clause is included in the majority of purchase contracts, incorporated by the agreement of buyer and seller.

Whenever a buyer fails to perform a material obligation agreed to in a real property sale and purchase contract, the buyer is deemed to have breached the contract. Most residential purchase contracts contain a provision which allows the buyer and the seller to agree in advance on the maximum amount of damages (so-called “liquidated damages”) a seller may recover through litigation if the contract is breached by the buyer. This limit is usually the amount deposited in escrow, but in the case of the transaction involving 1-4 residential units, one of which the buyer plans to occupy as buyer’s principal residence, it is usually further limited to no more than three percent of the purchase price. However, in the purchase of newly-constructed condos, the 3% limit may not apply – read the purchase contract, which is custom written by the developer and approved by the Bureau of Real Estate, very carefully.

For the liquidated damages provision of a purchase contract to become effective, it must be initialed by both the buyer and the seller. For any increased deposits to be subject to the provision, a separate, statutory liquidated damages form also must be signed.

Initialing or signing a liquidated damages provision or form is not a guarantee that the seller will recover liquidated damages. If the buyer disputes the provision, the seller still must prove in a court of law or in arbitration, among other things, that the contract was breached by the buyer. And even if the seller proves a breach, the buyer still can seek a return of the funds, or some portion of them, by challenging the “reasonableness” of the amount. Thus, for example, if within six months after the buyer defaults the seller can sell the property to another party for the same amount, the buyer may be entitled to a return of the deposit less any offsets for the seller’s carrying costs (e.g., interest on loans secured by the property, etc.).

Generally, the liquidated damages provision in most residential purchase contracts, when initialed by both the buyer and the seller, has no effect on the damages the buyer may recover from the seller if the seller breaches the contract. Buyers and sellers are urged to discuss any questions they may have regarding liquidated damages provisions with a qualified real estate attorney. Real estate brokers are not qualified to provide advice in this regard.

Here is the Liquidated Damages clause in the SFAR Purchase Contract (Revise Date 10/09), which would be incorporated only when initialed by both parties.:

“LIQUIDATED DAMAGES. If Buyer fails to complete this purchase because of Buyer’s default, Seller shall retain, as liquidated damages, the deposit actually paid. If the Property is a dwelling with no more than four units, one of which Buyer intends to occupy, then the amount retained shall be no more than 3% of the Purchase Price. Any excess shall be returned to Buyer. Release of funds will require mutual, signed release instructions from both Buyer and Seller, judicial decision or arbitration award. BUYER AND SELLER SHALL SIGN A SEPARATE LIQUIDATED DAMAGES PROVISION FOR ANY INCREASED DEPOSIT.”

This information in this article is mostly quoted from “GENERAL INFORMATION FOR BUYERS AND SELLERS OF RESIDENTIAL REAL PROPERTY IN THE CITY AND COUNTY OF SAN FRANCISCO” as published by the San Francisco Association of Realtors.

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