In Kuish v. Smith, No. G040743 (2010), a California Court of Appeal refused to allow the sellers of a residence to retain the buyer’s $600,000 deposit after the buyer defaulted. No, that’s not a typo–the property was “right on the beach in Laguna Beach,” and the contract price was $14 million.

The parties had agreed in their original agreement to a $400,000 deposit, which was to be increased by another $400,000 upon approval of contingencies. Both deposits were specified to be “non-refundable.” The parties subsequently signed escrow instructions, which they later amended to extend the closing date and decrease the total deposit to $620,000. They later further extended the closing date, and agreed to a release of $400,000 of the deposit to the sellers. The buyer then asked that the escrow be cancelled for reasons unstated, and the sellers agreed. A month later, the sellers sold the house to someone else, for $15 million. (These events took place in 2006, before the term “rising market” became a cruel joke.)

The sellers refused to return the $400,000 which had been released to them, and refused to instruct the title company to release the remaining $220,000 held in escrow back to the buyer, claiming that the entire deposit was “non-refundable.” Predictably, the buyer sued. The trial court ruled for the sellers, and the buyer appealed.

The Court of Appeal reversed, holding that, except for roughly $10,000 relating to roof repair costs (which was offset by interest on the deposit), the sellers were not entitled to retain any portion of the deposit. It is a basic rule of contract law that a party that breaches a contract should not have to pay a “penalty”–that is, an amount in excess of the other party’s actual damages. Here, since the sellers were able to sell the house for a higher price, they had suffered no damages, and thus were not entitled to anything.

The result wasn’t particularly remarkable, since the contract contained no liquidated damages provision–that is, a provision in which the parties agree that one party (usually the seller) is entitled to a specified amount of damages in the event of a breach by the other party. Many residential purchase agreements contain such a provision, usually allowing the seller to retain the deposit if the buyer breaches. (As a matter of custom, and a statutory presumption of reasonableness under California law, this deposit is often 3% of the purchase price.) However, the statutory requirements for liquidated damages provisions are extensively spelled out in the Civil Code. In this type of transaction, where residential property is to be occupied by the buyer and damages are liquidated in favor of the seller, the provision must be separately signed or initialed by the parties, and, if in a printed contract, must be in either 10-point bold type or contrasting red print in at least 8-point bold type. This was evidently not the case here, although we don’t know whether the provision was expressly negotiated out, or the parties simply neglected to initial the provision in a printed form. Either way, simply calling the deposit “non-refundable” wasn’t enough.

The sellers also tried to argue that they had agreed to extend the closing date in exchange for the buyer’s agreement that the deposit would be absolutely non-refundable. However, the Court refused to accept that argument, since the original purchase agreement provided for the deposit to be non-refundable, and the amendment that extended the closing date actually decreased the deposit amount. If the agreement had not originally made the deposit non-refundable, and the parties had subsequently agreed to extend the closing date in exchange for making the deposit non-refundable, the result probably would have been different.

In its discussion of the facts, the Court casually noted without discussion that “no attorneys fees were awarded to any party.” The American rule is generally that each party bears its own attorneys fees unless there is a provision in the contract or specific statute that authorizes recovery from the other party. Most contracts, and almost all printed form contracts, contain provisions allowing the prevailing party to recover its attorneys fees from the losing side. One would assume such a provision was not included in, or expressly negotiated out of, this agreement.

This case doesn’t break any new legal ground, and is more of interest because of the amounts involved and the fact that the parties were “big boys,” in the trial court’s words. It does, however, point out the importance of paying attention to the “boilerplate” provisions of a contract. Many buyers and sellers casually agree to the liquidated damages provisions contained in a printed form agreement. Had the parties done so here, the sellers probably would have been allowed to keep the $600,000. Further, had the contract contained a typical attorneys’ fees provision, the sellers probably could have recovered their attorneys fees from the buyer. The opinion doesn’t state the amount of the fees, but for a case like this which makes it to the Court of Appeal, each side’s fees could easily have been $50,000 to $100,000, if not more. Of course, the buyer is undoubtedly thrilled that the contract didn’t contain either provision, and it’s hard to predict which party the exclusion or inclusion of such provisions will favor in any contract. But each party to an agreement should give careful consideration to whether they want to include each “boilerplate” provision, especially when sums of this magnitude are at stake.