As I mentioned last week, sometimes life goes in a direction you don’t expect. This week, I’ll share some information about liquidated damages, specific performance, arbitration, and mediation. Before you put the paper down from unbearable boredom, let me put this another way. Here’s how to save yourself expensive court fees and legal hassles, and protect your investment.
Liquidated damages as it pertains to real estate is this: if someone breaks a promise resulting in your losing money, they owe you. More specifically, let’s say the Smiths agree to buy your house. They put down a deposit and sign an agreement that includes a liquidated damages clause, so you take the house off the market and decline an offer from another potential buyer. Then the Smiths back out and the market takes a hit. Your home is no longer worth what is was. You get to keep the Smiths’ deposit (or three percent of the purchase price—whichever is less).
The flip side of the liquidated damages coin is called specific performance. It comes into play when money cannot fix a problem. The determining factor is whether, in equity and good conscience, the court should specifically enforce a contract because the legal remedy of monetary damages wouldn’t adequately compensate the plaintiff for the loss. For example, let’s say the Smiths sign a contract to purchase that same home, but the sellers want to back out. The Smiths cannot simply go find another house, because this one is directly next door to Mrs. Smith’s ailing mother who needs constant assistance.
What’s the takeaway? If you’re a seller, consider a liquidated damages stipulation in your sales agreement: if the buyer backs out you at least get to keep the deposit up to the 3% of purchase price, but no more If you’re a buyer, the specific performance principle says there are circumstances under which a seller cannot back out of a transaction, but this is unrelated to liquidated damages.
If legal wrangling ensues, either about liquidated damages, specific performance, or any other legal issue, it may be worth considering arbitration or mediation. They are close cousins, and both far better dispute resolution alternatives than a court battle.
Arbitration occurs when two parties agree to settle a dispute with the help of an unbiased third party (arbitrator). Both parties agree in advance to comply with the arbitrator’s award; and then participate in a hearing at which both sides can present evidence and testimony. Even though the rules of evidence are not as strict as in a court case, the arbitrator’s decision is usually final, and courts rarely reexamine it. Arbitration is typically faster and cheaper than litigation.
Mediation is similar to arbitration, but is non-binding. In mediation, both parties agree to have an independent third party help settle a dispute; however, the mediator does not present a ruling or finding. Rather, he or she goes back and forth between the parties to share information and help everyone reach an agreement. The mediator impresses on both parties the benefits of compromise rather than the time, expense, and risk of a court case.
Before I close, I want to thank insurance agent Mark Davis for providing a correction to last week’s column: the Guaranteed Replacement Cost endorsement is relatively new in the insurance industry and was really brought to light after the Oakland Hills fire. This endorsement is generally 125 percent, 150 percent and up to 200 percent of the dwelling coverage on the homeowner policy. The purpose of the endorsement is to protect the homeowner against a sudden increase in replacement cost caused by shortage of labor or materials (e.g., a large disaster that causes sudden overcharging due to demand).
The coinsurance clause in a policy is generally 80 percent, 90 percent and 100 percent which requires the homeowner to insure the structure for those amounts in order to be eligible for “replacement cost” protection (no depreciation).
Next time I’ll write about whether IRAs are a smart source of funds if you want to invest in real estate. If there’s something you’d like me to write about or if you have questions about real estate or property management, feel free to contact me at firstname.lastname@example.org or visit our website at www.realtyworldselzer.com. Dick Selzer is a real estate broker who’s been in the business for more than 35 years.