January 17 – It is not uncommon for real estate transactions to require the purchaser’s deposit of a portion of the purchase price. The usual agreement provides that at some point in time the deposit becomes nonrefundable. A recent Court of Appeal decision has undermined the belief that “nonrefundable” always means just that.

William and Rhonda Smith owned a residence in Laguna Beach. In 2005, they entered into a written agreement to sell the residence to Bradford Kuish for $14,000,000. In 2006, escrow instructions were signed. They were subsequently amended. The final version called for a $620,000 deposit by Kuish. It also extended the escrow closing date. Kuish deposited the $620,000. The escrow officer then distributed $400,000 to the Smiths. The remaining $220,000 remained in escrow.

Thereafter, the escrow was canceled. Everyone signed the cancellation instructions.

The Smiths then turned to a backup offer they had received and sold the residence for $15,000,000.

Kuish demanded the return of his $620,000 deposit. The Smiths refused. Kuish initiated a lawsuit for the return of the deposit.

The trial court determined that only $20,000 of the deposit was refundable. The remainder was not. In its decision, the trial court stated that “both parties were ‘big boys,’ that is, sophisticated business people, [who] understood all the ramifications of their actions in freely negotiating to make the deposits non-refundable.”

Kuish appealed.

The Court of Appeal, aware of the status of the housing market at the time of the transaction, stated that when a seller seeks damages from a defaulting buyer during a period of rising property values, if the property has increased in value and the seller resells the property at a price equal to or higher than the consideration that would have been paid by the defaulting buyer, there are no longer any loss-of-bargain damages.

The appellate court reviewed a 1951 California Supreme Court decision that held any contractual provision that allows money or property to be forfeited without regard to actual damages constitutes an unenforceable penalty. The Supreme Court explained that if the seller is allowed to retain the amount of a down payment in excess of expenses associated with a contract breach, the seller is unduly enriched.

The Smiths argued that the agreement provided that the deposit was nonrefundable. The Court of Appeal responded that to construe the term “nonrefundable” as establishing the Smiths’ entitlement to the full deposit without regard to actual damages would essentially create a liquidated damages provision. However, the parties stipulated that the agreement did not contain a liquidated provision. For the sake of argument, the court stated that even if the nonrefundable deposit language of the agreement could be construed as a liquidated damages provision, such a provision would be unenforceable because it failed to meet the requirement in the Civil Code that the provision must be separately signed or initialed by each party to the agreement.

Since the agreement contains no liquidated damages provision, the deposit could have been retained only had the Smiths suffered any actual damages. They did not.

The judgment of the trial court was reversed and the matter was sent back to the trial court to issue a new judgment consistent with the opinion of the Court of Appeal.

The case is entitled Kuish v. Smith. It was decided in 2010.

This case is entitled Ennabe v. Manosa. It was decided in 2010.

(Tom Ramsey is a Long Beach attorney who has specialized in business law for more than 40 years. He may be reached at bizlawwiz@aol.com.)