Hello everybody. It has been many years since I have written about the remedies available to a buyer when the seller of an apartment building backs out of the transaction or refuses to close the escrow. So now would be a good time to review and update the rights a buyer has.
A seller’s breach of a purchase contract followed by his refusal to perform gives rise to four general remedies, to wit: a buyer’s action for damages, an action for specific performance, an action for breach of the warranty of authority, and an action for rescission.
In addition, if the buyer sues for specific performance, he may serve by mail on the seller and then record a Notice of Pendency of Action (i.e. lis pendens) with the county recorder of the county in which the apartment complex is located. For all practical purposes, that recordation makes it impossible for the owner to resell his property to someone else or to refinance it.
The fundamental remedy a purchaser has against a breaching seller is an action for money damages. Civil Code §3306 provides this remedy. If the seller refuses to perform his contract, the buyer is entitled to recover from the seller the difference between the market value of the property at the time the seller breaches (such as when the seller cancels the escrow or refuses to record his deed) minus the purchase price the buyer agreed to pay under the contract.
What that means is that if the market value of the property at the time of the breach is higher than the contract price, the buyer may recover the difference. Market value is usually determined by the testimony of a qualified appraiser.
If the market value on the date of the breach is equal to or less than the contract price, then the buyer is, for the most part, not monetarily damaged. However, I should qualify that statement by mentioning that in a suit for damages, the buyer may additionally recover from the breaching seller the money the buyer paid to examine the title and prepare the necessary documents, together with certain consequential damages, even if the market value does not exceed the contract price.
Here is an illustration: Assume that the purchase price under the contract for the purchase of a 25 unit apartment building is 4 million dollars. Also assume that the buyer (or his broker) negotiated that as a great price for the buyer because the market value of the property was actually 4.5 million dollars. As escrow progressed, other brokers advised the seller that with the “hot” real estate market, the value of the property increased to 4.7 million dollars. The seller then backs out of the deal believing that the contract price was not fair. The buyer then sues for $700,000 as the difference between the higher market value of the property at the time that the seller cancels and the lower contract price. Who wins?
The answer is that the court will likely find in favor of the buyer and against the seller for $700,000, plus the buyer’s attorney’s fees, court costs and other consequential amounts. While the seller will retain ownership of the property, he will have to pay the buyer all of the damages awarded by the court. Unlike an action for specific performance (discussed in the next section), the court is usually not concerned about the fairness of the purchase price, but only whether or not the contract was valid at the time it was executed.
When the seller breaches, the buyer’s typical objective is to acquire ownership of the property rather than receive an award of damages. In other words, he wants the court to order the seller to obey the contract and convey the property to him. This form of remedy is available in an action for specific performance.
There, the buyer files suit asking the court to order the seller to complete the terms of the contract by recording the deed or instructing the escrow officer to record the instrument. Of course, the buyer has to pay the purchase price to the seller as a condition to the court’s order to convey the property.
To obtain specific performance, the buyer must prove to the court that at the time the contract was signed, the price and terms were fair to the seller. In other words, if the contract purchase price was $2,000,000, but at the time the agreement was signed the market value was $4,000,000, the court is likely to determine that the price was unfair and deny specific performance. (See Yackey v. Pacifica Development Co., 99 Cal.App. 3d 776, 783.)
However, in such a case the court could (and should) still award the buyer monetary damages equal to the difference between the market value ($4,000,000) and the contract price ($2,000,000), yielding a judgment in favor of the buyer for $2,000,000. Unfairness of the price or the terms of a valid contract are not a defense to the buyer’s action for damages, even though they are a defense to a cause of action for specific performance.
Thus, even if the court finds that the price was unfair and refuses to grant specific performance, it may nevertheless award damages as discussed above.
With specific performance, another issue for the court to consider (and this is where things get complicated in the courtroom) is whether there was any change to the interest rate the buyer will have to pay the lender as a result of the seller’s delay in consummating the sale. If the interest on the buyer’s proposed financing increases over the course of the litigation (which will likely be a year or more), the court has the power to adjust the purchase price to compensate the buyer for the additional interest expense he would have to pay over the projected life of the loan.
That is particularly significant where the buyer has applied for a fixed, rather than an adjustable, interest rate. Obviously, if the fixed interest which the buyer might have obtained at the scheduled close of escrow was, say, 5% per annum, but at the conclusion of the litigation it has risen to 6.5%, the additional cost to the buyer during the term of the loan will be substantial. The court may fashion a judgment to adjust the consideration the buyer must pay the seller to offset the cost of the increased interest. (AOA members who are lawyers and who wish to research this accounting issue should begin with Hutton v. Gliksberg, 128 Cal.App. 3d 240.)
To obtain specific performance the buyer must also prove to the court that as of the original scheduled date for the close of escrow, the buyer would have been able to obtain the necessary financing to pay the purchase price, or alternatively, that he had the financial wherewithal and willingness to deposit the full purchase price into escrow (as an “all cash” deal) if the lender did not approve the financing. (AOA attorney members will find a further and outstanding discussion of these funding issues in C. Robert Mattress v. CIDCO, 184 Cal.App. 3d 55, and Am-Cal Investment Co. v. Sharlyn, 255 Cal.App. 2d 526.)
Incidentally, if the seller misrepresented a material aspect about the property which, if it had been known to the buyer, would have reduced the market value, the buyer may close the escrow with the seller and thereafter sue the seller for damages arising from the misrepresentation. (Lawyers wanting a detailed explanation of this principle should review Jue v. Smiser, 23 C.A.4th 312.) On this same point, AOA members who are not attorneys should review my article in the March 2014 issue of this magazine entitled “Liability for Misrepresentation of Lot Size.”
Breach of Warranty of Authority
Another cause of action which a buyer would have under appropriate facts is a claim for Breach of Warranty of Authority.
Occasionally, a co-owner of property will sign a purchase agreement on behalf of the other co-owner, such as a husband signing for himself and his wife. If the spouse or other co-owner who is on record title thereafter refuses to sell the property to the buyer, the buyer may be precluded from obtaining specific performance or damages (discussed above) on the basis that the contract is not valid or it is otherwise unenforceable. However, the buyer may have a separate and independent cause of action against the single-signing owner for Breach of Warranty of Authority.
California follows a law known as the “Equal Dignities Rule.” That rule provides that if a contract is required to be in writing (which is the case with the sale of an apartment building), then any representative or agent who signs the contract on behalf of one or more of the owners, must have previously obtained written authority from the non-signing owner(s) to do so. If the representative executes the contract without having that written authority, the agent may be liable to the buyer for compensatory damages and, perhaps, punitive damages for the breach of a warranty of authority. (AOA lawyers wishing to further research this cause of action should review the annotations to Civil Code Section 3318.)
The essence of the Breach of Warranty Cause of Action is that the individual signing the contract implicitly warrants to the buyer that the individual has all the necessary authority to sell the property. If he doesn’t, he will be liable to the buyer for a breach of that warranty.
Finally, the buyer may sue the seller for rescission (i.e., cancellation of contract) if the seller backs out of the deal. Ordinarily, a buyer would only file such a suit if the seller refuses to instruct the escrow holder to refund the buyer’s deposit. But that is often the case if the seller contends that it was not he, but rather the buyer, who breached the contract. The seller may claim that he is entitled to receive the deposit being held in escrow as liquidated damages for the buyer’s breach.
Although it only applies to buildings with four or less residential units, California Civil Code Section 1057.3 provides that if the seller wrongfully refuses to execute documents necessary to release the deposit to the buyer after the escrow fails to close by the date specified in the instructions, the buyer can sue to recover the deposit plus a penalty of three times the amount of the deposit (but not more than $1,000), plus attorney’s fees. The penalty does not apply if the funds are withheld to resolve a good faith dispute. Further, the penalty is only applicable to residential property consisting of no more than four units, and the buyer must intend to occupy one of the units. If those conditions are not met, then a successful buyer will receive a refund of his deposit without the penalty being assessed.
Impact of a Lis Pendens
After (but not before) a buyer files a lawsuit against the seller for specific performance, the buyer may mail to all owners of record of the property and then record a Notice of Pendency of Action. That document, more commonly known as a lis pendens, creates an encumbrance against the seller’s property, which, for all practical purposes, makes the seller’s title unmarketable to any other purchaser and unfinanceable by a lender. The recordation of the instrument with the county recorder of the county in which the apartment tenement is located largely eliminates the seller’s ability to sell, transfer or refinance his property.
The Superior Court has the power to expunge (i.e. remove) the lis pendens from the records of the County Recorder. In general, that removal is discretionary with the judge (based upon a number of factors), but if the judge refuses to remove it, title to the seller’s property is encumbered throughout the one or more years during which the litigation proceeds.
Incidentally, in a recent Court of Appeal case ordered published on January 26, 2016, the appellate court seems to hold that if the plaintiff does not mail a copy of the lis pendens to all owners of record, the lis pendens is void even if the owner in question received the document by personal service. (See: Rey Sanchez v. PCH Enterprises)
The buyer’s recordation of the Notice of Pendency of Action exposes the seller to two substantial risks. If the market value of the property increases over the next 12 or more months, and if the buyer then ultimately prevails at trial, the buyer will be able to purchase the apartment building based on the original contract price without having to pay for the market appreciation. Such a risk often induces a seller to settle with the buyer early in the litigation.
Conversely, if the property declines in value, the buyer can withdraw the lis pendens, dismiss the litigation, and walk away from the transaction, which is an additional reason why the seller may desire an early settlement. He will be left with a building which declined in value over the course of the litigation.
It has always been my view that litigation should be a remedy of last resort, rather than one of first action. In situations where the buyer and seller are not personally able to resolve their differences, then mediation should, in my opinion, be engaged in between the parties before judicial action is filed, unless delaying the court proceeding will jeopardize the rights of one party or the other (such as the rights of the buyer if the seller is likely to swiftly sell the property to someone else because a lis pendens was not recorded).
Many contracts now affirmatively require a buyer to attempt to mediate his or her dispute with the seller prior to filing a lawsuit. Of course, if the buyer is concerned that the seller will re-sale the property in the interim, then it would be prudent for the buyer to promptly file a lawsuit so as to enable a lis pendens to be recorded. Mediation should follow shortly thereafter.
Dale Alberstone is a prominent litigation and transactional real estate attorney who has specialized in real property law for the past 39 years. He has been appointed to periodically serve as a judge pro tem of the Los Angeles Superior Court and is a former arbitrator for the American Arbitration Association. He also testifies as an expert witness for and against other attorneys who have been accused of legal malpractice.
Mr. Alberstone has been awarded an AV rating from Martindale-Hubbell. An AV rating reflects an attorney who has reached the heights of professional excellence and is recognized for the highest levels of skill and integrity.
The foregoing article was authored in February, 2016. It is intended as a general overview of the law and may not apply to the reader’s particular case. Readers are cautioned to consult an advisor of their own selection with respect to any particular situation.
Questions of a general nature are warmly invited. Address correspondence to Dale S. Alberstone, Esq., ALBERSTONE & ALBERSTONE, 1900 Avenue of the Stars, Suite 650, Los Angeles, California 90067. Phone: (310) 277-7300.