Michael Newhouse: Recovering Damages Through Escrow
- Jan 06, 2015
Most developers have been there a few times. You found a great property, it’s well priced, and perfect for your newest development; be it a flip or an income property.
You’ve deposited your earnest money, you’ve cleared all contingencies, you’ve begun work with your architect, engineer and subs, and closing is imminent. But … the seller has begun acting erratically, alternating between refusing to close escrow and stating they would complete the transaction. Maybe they are even trying to get more money out of you, thinking that they sold too cheap. You, or your broker, have explained, and threatened, the consequences of refusing to close the deal, but the seller is not responding to reason. What do you do now?
Too often, especially where the purchase price does not exceed $1,000,000, a developer’s instinct, ratified by their broker’s or attorney’s advice, is to either: 1) accept the extortion of a raised purchase price as the “cost of doing business”; or 2) let the deal go, get back your deposit, and move on to another property; rather than spend time and legal fees forcing the sale, commonly known as a Specific Performance lawsuit.
This article discusses a seldom considered “third option”: a Specific Performance lawsuit, with a demand that all damages – including attorneys’ fees and costs, encumbrances and lost future rents or profits due to delays in closing – be paid directly as escrow credits following a court ordered closing.
As is well understood by most real estate law practitioners, and their clients, forcing a sale through “Specific Performance” is available where: 1) the buyer has put the seller on notice of its demand that escrow close; 2) the buyer has “substantially” performed its end of the bargain (e.g., paid its earnest deposit and cleared its contingencies, etc.); 3) the seller has not performed (e.g., refuses to close escrow); 4) the purchase and sale agreement (“PSA”) terms are sufficiently definite (which is generally the case in any legitimate real property transaction); 5) the PSA is reasonable and fairly priced (e.g., the seller is not being unfairly taken advantage of); 6) the terms of the requested “forced sale” are “substantially similar” to the terms of the PSA; and 7) the buyer’s “legal remedy” (i.e., simply getting a money judgment against the breaching seller) is inadequate. (Civil.Code §§ 3384-3395; Tamarind Lithography Workshop, Inc. v. Sanders (1983) 143 Cal.App.3d 571, 575; Byrne v. Laura (1997) 52 Cal. App. 4th 1054, 1071).
DAMAGES PAID THROUGH ESCROW “CREDITS”
While there is nothing terribly novel about obtaining a judgment for specific performance where that above factors are satisfied, having attendant damages, including prospective lost profits, deducted directly from the purchase price in escrow is a little known and obviously very attractive option for buyers. Having such damages “directly paid” to the buyer obviously removes the single most difficult step in the litigation process; collection.
1. Deducting Damages Due to Liens, Taxes and other Encumbrances
If liens, claims or other defects in title exist, a seller may be required to convey what interest he or she has in the property and the buyer may receive compensation for the deficiency in performance. (Sequoia Inv. Corp. v. Paillard (1995) 135 Cal. App. 2d 166, 172.) Moreover, most standard PSAs clearly require that taxes be “paid current” and prorated between buyer and seller.
Thus, in addition to an order of specific performance, buyers should ask the court to direct that common debts such as property taxes and judgment liens be deducted from the purchase price and/or paid and satisfied through escrow before title passes to the buyer.
2. Deducting Lost Rent or Profit Damages Due to Delayed Performance
Because a buyer seeking specific performance has lost possession and use of the property during the delay in receiving title, that buyer is entitled to offset from the purchase price any lost rents or profits and increased costs caused by the delay. (Bravo v. Buelow (1985) 168 Cal. App. 3d 208, 213-215 (buyer credited $70,000 for increased construction costs of $20/SF resulting from delay); Hennefer v. Butcher (1986) 182 Cal. App. 3d 492, 505 (increased development costs $150,000 offset from $1.05 million purchase price); Greenstone v. Claretian Theological Seminary (1959) 173 Cal.App.2d 21 (offset of lost rentals). Such offset or credit is not a breach of contract damage, but designed to relate specific performance back to the date escrow was supposed to close and adjust the equities between the parties due to delayed performance. (Id.) To obtain such credit and offset, no specific pleading is required. (Greenstone, 173 Cal.App.2d at 34-35.
3. Attorneys Fees
Finally, buyers should make sure to seek all attorneys fees and costs associated with the specific performance action. Such fees and costs are of course not generally available under statute, but are almost always specifically provided for in the PSA.
In short, before letting a recalcitrant seller off the hook, on an otherwise good deal, purchasers should consider their “third option”, a Specific Performance lawsuit that seeks all damages through a court ordered closing.