HOUSE BILL REPORT
SHB 1699
As Passed House:
March 8, 2005
Title: An act relating to agreements for the purchase and sale of real estate.
Brief Description: Regulating agreements for the purchase and sale of real estate.
Sponsors: By House Committee on Judiciary (originally sponsored by Representatives Lantz, Priest and Tom).
Brief History:
Judiciary: 2/16/05, 2/18/05 [DPS].
Floor Activity:
Passed House: 3/8/05, 96-0.
Brief Summary of Substitute Bill |
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HOUSE COMMITTEE ON JUDICIARY
Majority Report: The substitute bill be substituted therefor and the substitute bill do pass. Signed by 10 members: Representatives Lantz, Chair; Flannigan, Vice Chair; Williams, Vice Chair; Priest, Ranking Minority Member; Rodne, Assistant Ranking Minority Member; Campbell, Kirby, Serben, Springer and Wood.
Staff: Christopher Abbott (786-7119).
Background:
Liquidated Damages Clauses
When a party breaches a contract with another, the party hurt by the breach has several
options. For instance, the injured party may sue for damages, seek restitution or return of
property held by the breaching party, or request that the court compel the breaching party to
perform its end of the bargain. The parties may also specify other remedies in the contract
itself.
Sales contracts often include a "liquidated damages" clause. These clauses establish a
defined amount of money that the parties agree to pay as damages if they breach the
agreement. Parties use liquidated damages agreements to reduce litigation over damages and
manage risk when the parties have difficulty predicting the actual harm of a contract breach.
Common Law Requirements for Liquidated Damages Clauses
Courts will not enforce liquidated damages clauses unless they satisfy several common law
requirements. Most importantly, the amount specified in the liquidated damages clause must
be a reasonable estimate of the possible harm from a future breach. Traditionally, courts
would also only enforce the clause if the parties inserted the clause because of anticipated
difficulty in determining actual damages when a breach occurs. More recently, however, the
state Supreme Court has treated actual damages more as a factor in evaluating the
reasonableness of the liquidated damages clause than as an independent requirement.
Much of the controversy concerning these clauses revolved around whether an injured party
must prove actual damages from the breach before claiming the liquidated damages amount.
Before 1989, courts never considered actual damages. In Lind Building Corporation v.
Pacific Bellevue Developments, however, the Washington Court of Appeals departed from
the traditional view, holding that a party who does not prove any actual damages could not
enforce the liquidated damages clause even if its estimate of future damages was reasonable
when first written. Five years later, the Washington Supreme Court overruled Lind, holding
that lower-than-expected actual damages were, at most, evidence of an unreasonable
liquidated damages clause.
Earnest Money Deposits
Many real estate transactions use an earnest money deposit provision. One party (typically
the purchaser) agrees in the purchase and sale agreement to deposit a sum of money. A party
forfeits the deposit by breaching the contract, allowing the other party to keep the money.
Courts treat these arrangements as a form of liquidated damages.
In 1991, the Legislature responded to the Lind decision by creating a new law governing
earnest money deposits. RCW 64.04.005 guarantees enforcement of an identified earnest
money clause regardless of actual damages so long as the clause satisfies the law's
requirements. This guarantee only applies when the agreement designates payments as an
earnest money deposit and provides that forfeiture of the deposit is the seller's exclusive
remedy if another party backs out of the deal.
For earnest money provisions to be enforced under RCW 64.04.005, they must meet the
following amount, language, and notice requirements:
Consequences of Defective Earnest Money Forfeiture Clauses
According to a recent court of appeals decision, RCW 64.04.005 bars enforcement of an
earnest money clause when the clause is defective with respect to the amount, language, and
notice requirements. In Chrisp v. Goll, decided January 3, 2005, the home seller elected
forfeiture of an earnest money deposit as the sole remedy, but the parties did not separately
initial the clause as required by law. The court refused to enforce the earnest money
provision, holding that the statute's plain language required that the parties retain all remedies
allowed by law if the earnest money clause violated the amount, language, and notice
requirements. Consequently, if the purchaser reneges on a deal with a defective earnest
money clause, the seller may pursue remedies in addition to recovery of the earnest money
deposit. Chrisp is currently being appealed.
The consequences of violating the amount, language, and notice requirements do not apply to
liquidated damages clauses that are not earnest money deposits within the scope of the
statute. For example, courts have upheld contracts where the total amount forfeited
(including an earnest money deposit and other payments) is as much as 17 percent of the
purchase price so long as the earnest money portion itself is no greater than 5 percent of the
price. Similarly, if forfeiture of the deposit is not the sole and exclusive remedy, the statute
does not apply, and the provision need not meet the amount, notice, and language
requirements. These liquidated damage clauses must still comply with the common law
reasonableness requirement.
Summary of Substitute Bill:
Liquidated Damages
The guaranteed enforcement requirement in RCW 64.04.005 is extended to all forms of
liquidated damages clauses in real estate agreements. Courts must enforce the liquidated
damages clause regardless of the seller's actual damages if the following conditions exist:
These requirements apply equally to residential and commercial property transactions.
Liquidated damages clauses that do not satisfy the statute's requirements are instead governed
by the common law requirements.
Earnest Money Deposits
The notice and language requirements are eliminated, making the requirements for
guaranteed enforcement of earnest money deposits identical to the requirements for all
liquidated damages clauses. Courts must now enforce an earnest money forfeiture clause
regardless of the seller's actual damages if the following conditions exist:
These requirements apply equally to residential and commercial property transactions.
Consequences of Defective Earnest Money Forfeiture Clauses
Failure to meet the statutory requirements no longer renders the earnest money forfeiture
clause totally ineffective. Instead, courts will evaluate a defective earnest money deposit
clause under the common law liquidated damages requirements.
Appropriation: None.
Fiscal Note: Not requested.
Effective Date: The bill contains an emergency clause and takes effect immediately.
Testimony For: Real estate agreements are in a limbo because of the recent Appeals Court decision. After the Court of Appeals changed the rules for enforcing earnest money forfeiture clauses, the Legislature enacted a safe harbor statute to provide a means for parties to guarantee that these clauses would be enforced. The requirement that the parties initial the clause was intended to further consumer protection, but it became a problem when parties often forgot to include their initials. After the Washington Supreme Court overruled the earlier Appeals Court decision, all standardized real estate forms eliminated the initialing requirement as unnecessary. In December 2004, the Court of Appeals interpreted the safe harbor statute as the exclusive means of enforcing liquidated damages and the initialing requirement as necessary. Because of that decision, purchase and sale agreements now either lack an enforceable earnest money forfeiture clause or, in the worst case scenario, are not binding agreements at all. This bill would address an emergency and needs an emergency clause.
Testimony Against: None.
Persons Testifying: Representative Lantz, prime sponsor; and Bob Mitchell and Annie Fitzsimmons, Washington Association of Realtors.