Last year, the current downturn in the residential housing market was revealed. The trend appears to be continuing into 2007, as many condominium developers are planning to close condominium units that were sold to purchasers during the hot condominium market of 2003 through 2005. In-evitably, some of those purchasers who agreed to pay top-dollar for a condominium during the craze will have second thoughts about whether they want to actually close on the purchase. Many of these purchasers may want to terminate their purchase agreement, while at the same time, obtain a return of deposits that were placed into escrow. Most condominium developers include liquidated damages clauses in their purchase agreements that are designed to control the outcome of such situations. Given the current market, it’s worth-while to take another look at the law in Nevada as it relates to the enforceability of such clauses.
Liquidated damages are a sum that a party agrees to pay should they fail to perform. The Nevada Supreme Court has held that liquidated damages clauses are prima facie valid. The court has further noted that damages in the event of breach of a real estate contract are difficult to estimate with certainty. However, the court has also held that a liquidated damages provision may amount to an unenforceable penalty. The distinction between a penalty and liquidated dam-ages is that a penalty is a punishment for default, designed to secure performance, while liquidated damages are a measure of compensation for non-performance.
In order to show that a liquidated damages provision constitutes a penalty, the party challenging it must show that the amount of liquidated damages is disproportionate to the actual damages sustained by the non-breaching party. Historically, this has not been as difficult when the real estate market consists of a steady increase in fair market values of resi-dential properties. Many developers have been reluctant to attempt to enforce liquidated damages when facing a likelihood of being able to re-sell a property at the same, or a higher price. The fact that a developer benefited financially from a buyer’s decision to terminate a purchase agreement almost certainly makes the buyer’s obligation to show that the liquidated damages are disproportionate to actual damages easier. In the current market, however, developers may be reconsidering their ability to withstand a challenge to liquidated damages, especially if they believe that the fair market value of a particular condominium unit is substantially less today than it was when the purchase agreement for that unit was executed.
In considering whether to seek liquidated damages, developers will want to conduct a case-by-case evaluation. While the overall trend may currently consist of stagnant or declining prices, this may not necessarily be true for every development, or every unit. Factors the developer will want to consider may include the amount of liquidated damages identified, the fair market value of the property, the cost to the developer in terms of litigation expenses and the impact that engaging in battles over liquidated damages has upon the developer’s reputation. The developer will also want to identify and understand other potential limitations upon its ability to enforce liquidated damages, such as federal and state regulations pertaining to common interest communities, including limitations contained within the Inter-state Land Sales Act. Competent legal counsel should always be consulted prior to deciding upon an appropriate course of action.
Liquidated damages can be an effective way for parties to identify in advance an appropriate measure of compensation to a developer should a buyer decide not to proceed with its condominium purchase. In the current real estate market, more developers may be taking a closer look at them in evaluating their options when buyers breach.