COVID, Cancellations, and Non-Refundable Deposits

You may have heard that the Coronavirus has caused innumerable cancellations of birthdays, conferences, weddings, sales contracts, and purchase agreements, including for real estate transactions. You are probably also wondering whether you can get back, or perhaps keep, a “non-refundable deposit” paid for an event. The answer, naturally, is that it depends on its characterization.

California Civil Code section 1671, subdivision (d), addresses something known as “liquidated damages” clauses for breaches of contract. Generally, liquidated damages clauses are prohibited under that section for the retail purchase or rental of personal property or services for a party’s personal, family, or household purposes, except that the parties may agree on an amount due as damages when one party breaches. Similarly, Civil Code section 3369 prohibits any specific or preventive relief to enforce a penalty or forfeiture “in any case,” except in the case of a “nuisance” or when otherwise provided by law.

Of course, the next question is what is required for a “valid” liquidated damages provision. Although Civil Code section 1677 applies to the sale of real estate, it is helpful because it provides that a liquidated damages clause is invalid unless the provision (a) is separately signed or initialed by each party and (b) it is set out in 10 point bold font, or in 8 point red font.

During the last economic crises, the California Court of Appeal addressed this topic in a case known as Kuish v. Smith (2010) 181 Cal.App.4th 1419. There, a plaintiff offered to buy the defendants’ house in Laguna Beach for $14 million as part of a written sale agreement that required the plaintiff to make two “non-refundable” deposits totaling $600,000, before later backing out. Instead, the defendants sold the home to another buyer, and kept the $620,000 “non-refundable deposit.”

After trial, the Court ruled in favor of the defendants finding that the “non-refundable deposit” was not a “forfeiture” because it constituted “separate and additional consideration for extending the time and length [of] keeping escrow open for nine months.” The plaintiff appealed.

The Appellate Court reversed, finding that the deposit would have been non-refundable in a falling market only to the extent that defendants were able to show damages under Civil Code section 3307. (Kuish, 181 Cal.App.4th at 1429.) The Court of Appeal quoted liberally from Freedman v. St. Matthias Parish, 37 Cal.2d 16, 22, which noted that “A penalty need not take the form of a stipulated fixed sum; any provision by which money or property would be forfeited without regard to the actual damage suffered would be an unenforceable penalty. Such penalties cannot reasonably be justified as punishment for one who willfully breaches his contract.” (Kuish, 181 Cal.App.4th at 1427.) The Appellate Court concluded that to “construe the term ‘non-refundable’ as establishing defendants’ entitlement to the full deposit without regard to the actual damages would essentially create a liquidated damages provision.” (Id. at 1429.) Thus, Kuish illustrates that a non-refundable deposit may be retained to compensate a party for a breach where the evidence supports that amount as damages, but not in an amount exceeding those damages.

In the midst of the current Coronavirus pandemic, parties to contracts of all shapes and sizes would benefit from keeping this in mind.

by Eli Underwood for Krogh & Decker, LLP, Business Attorneys (916) 498-9000 or www.kroghdecker.com/contact

Sacramento Business Attorneys