When is a non-refundable deposit refundable?

April 10th, 2010
By: Erich Schiefelbine, Stephens Friedland LLP

Recently, in Kuish v. Smith, 181 Cal. App. 4th 1419 (2010), the Fourth District Court of Appeal addressed the issue of when a non-refundable deposit in a real estate transaction is actually refundable.   The answer may be:  In a rising market.

Kuish entered into a written agreement to purchase Smith’s home in Laguna Beach for $14 million.  Kuish later unilaterally cancelled escrow on the property and the Smiths promptly sold the property to a third party for $15 million.  The Smiths refused to return any of Kuish’s $620,000 deposit, relying on the description of the deposit as non-refundable.

Kuish filed a complaint containing claims for conversion, unjust enrichment, money had and received, and declaratory relief.  Kuish sought the recovery of the entire $620,000.

The trial court found that $20,000 of the deposit was refundable.  The $600,000 was found to be non-refundable and did not constitute a forfeiture because both parties were “big boys” who understood the ramifications of their actions in negotiating the deposit as “non-refundable.”  The court held that the entire deposit was “the separate and additional consideration for the escrow being open for nine months.”

The Court of Appeal pointed out that in a “rising market” a seller of real property is limited to the recovery of consequential damages and interest under Civil Code section 3307.  Seller’s main damages are the difference between the contract price and the property’s value at the time of breach.  In a rising market, when a seller seeks damages from a defaulting buyer, if the property has increased in value before trial and the seller resells the property at a price equal to or higher than the value of the contract, there are no longer any loss-of-bargain damages.

The appellate opinion likened forfeiture of the deposit to a “penalty” is analogous to liquidated damages.  Civil Codes sections 1670 and 1671 state that “A penalty need not take the form of a stipulated sum; any provision by which money or property would be forfeited without regard to the actual damage suffered would be an unenforceable penalty.”  Without a valid liquidated damages clause the seller may retain the deposit only to the extent that actual damages were incurred according to Civil Code section 3307.

Essentially, in this instance, according to the Court of Appeal, the trial court created a liquidated damages provision in the contract by construing the term “nonrefundable” to entitle the defendants to the full deposit without regard to actual damages.  Notably, however, a potentially contrary view was set forth in Horowitz v. Noble, (1978) 79 Cal.App.3d 120.

In the end, the Kuish matter was remanded for a determination of the proper amount to be refunded.  Thus, in property transactions, buyers and sellers alike should remember that the common term “non-refundable” may have a variety of meanings dependant on the facts of each individual case.

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