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MEDIATION, ARBITRATION AND LIQUIDATED DAMAGES

by | Oct 18, 2022 | Arbitration, Mediation and Liquidated Damages

BROKER RISK MANAGEMENT
WEEKLY PRACTICE TIP

Q:  I am always asked by my buyers and sellers whether they should initial the Liquidated Damages and Arbitration clauses in the Purchase Agreement.  Some agents tell me that they always tell their clients to initial those paragraphs.  Others say that the client must decide.  What is the best practice here:

A:  This is a very common problem for agents.  It is a mistake for agents to have a preconceived opinion as to whether a client should initial either of those paragraphs.  The client must decide for themselves. This decision involves both legal and transactional considerations:

  1. LEGAL CONSIDERATIONS:

With regard to liquidated damages, the parties are presetting the amount of damages in the event that the buyers breach the purchase and sale agreement.  There is a legal presumption that for properties that are 1-4 residential units, one of which buyer intends to occupy, up to three percent (3%) is reasonable.  For any amounts over four percent (4%), the burden of proof shifts to the sellers to prove the liquidated damages amount is reasonable.  In an increasing market, liquidated damages favors sellers because the property may have increased in value, but they recover the buyers’ deposit leading to a windfall for the sellers.  In a declining market, liquidated damages favors buyers because it limits their damages to potentially less than the decline in the value of the property.

By agreeing to arbitration, a seller or buyer is making a legal choice as to whether to have an arbitrator hear a dispute, or whether to go through the court system.  In deciding to go to arbitration, a seller and buyer are giving up the right to a jury trial, and almost all rights of appeal.  There are very limited grounds on which a party can appeal a wrong decision by an arbitrator.

It is routinely argued that to give clients advice whether to initial these paragraphs is to engage in the practice of law.  For these reasons, it is not wise for agents to advise clients that they should initial these paragraphs.

  1. TRANSACTIONAL CONSIDERATIONS: In some markets the expectation by agents (and perhaps their clients) that these paragraphs will be a part of a purchase agreement is so high that offers are considered weaker, or even defective, if these paragraphs are not initialed.  In multiple offer situations, this can possibly put a buyer’s offer at a disadvantage.  This market-imposed bias can also be a factor to be considered by clients as to whether they want to agree to those paragraphs.
  1. CAR MEMOS: To assist agents in guiding their clients with this decision, the California Association of REALTORS® has prepared several memos that are very helpful in these areas.
  1. MEDIATION: Mediation is automatically included in virtually all standard residential purchase agreement forms.  This paragraph obligates sellers and buyers, but not their agents, to mediate their disputes related to the purchase agreement.  CAR has created a Legal Memo explaining the mediation process entitled “Mediation for the Consumer” which can be found at:

https://www.car.org/riskmanagement/qa/arbitration-folder/mediationconsumer

 

  1. ARBITRATION: Likewise, when clients have questions about whether they should initial the arbitration clause, this guide from CAR entitled “Arbitration for the Consumer” will go a long way toward helping the client decide what to do:

https://www.car.org/riskmanagement/qa/arbitration-folder/arbitrationconsumer

  1. LIQUIDATED DAMAGES: Finally, with respect to liquidated damages, agents should not recommend that clients initial this paragraph.  Having this paragraph as a part of the purchase agreement does not always favor sellers over buyers or buyers over sellers.  It will ultimately depend on many factors as to whether this paragraph will ultimately be to the benefit of either seller or buyer, as opposed to the alternative of having actual damages be the measure of seller recovery from a breaching buyer.  So, to help the clients decide, CAR has prepared this Legal Memo entitled “Liquidated Damages and Deposit Disputes” to answer the many questions clients, and their agents have, regarding this confusing area of practice:

https://www.car.org/riskmanagement/qa/contract-forms-folder/liquidateddamagesdepositdisputes

PRACTICE TIPS:

  1. PURCHASE AGREEMENTS: Do not require your clients to initial either the Liquidated Damages or Arbitration paragraphs.  The decision must be theirs.

Because you know that questions about initialing the liquidated damages and arbitration paragraphs will arise at the time of the signing of the purchase agreement, it is a recommended practice to have a discussion with clients about decisions this early on in your relationship with them.

To that end, give sellers and buyers a copy of the Residential Purchase Agreement when you start working with them and tell them to read it, pointing out the liquidated damages and arbitration paragraphs, and to bring any questions to you so that they are prepared when it comes time to write the offer.

Also, give your client the CAR memos mentioned above on these subjects and ask them to read them as well, so that they have had an opportunity to decide whether to initial these paragraphs when the time comes.

  1. LISTING AGREEMENTS: Note that CAR (and PRDS) has removed the arbitration clause from its listing agreements. This was because, although those arbitration provisions stated that they only applied to disputes between sellers and brokers regarding broker compensation, judges would regularly require the brokers to participate in damages arbitrations between sellers and buyers.

If a client insists that there be an arbitration clause in the listing agreement, discuss that with your manager or broker.  If your brokerage is willing to accept an arbitration clause into your listing agreement, CAR has an Arbitration Agreement form (form ARB on zipForms) for that purpose.

  1. MEDIATION: Only sellers and buyers are obligated to mediate disputes between them arising out of the purchase agreement. The agents for sellers and buyers are not obligated to attend mediations or arbitrations, and should never do so without their broker or manager’s approval.

Agents should always advise their clients in writing to consult with a qualified California real estate attorney regarding any disputes they may have with the other party.  However, for those clients who do not wish to hire an attorney for mediation, the CAR Purchase Agreement Mediation paragraphs reference the “CAR Real Estate Mediation Center for Consumers” as a forum for mediation.

  1. SMALL CLAIMS COURT EXCLUSION: All standard purchase agreement forms have an exclusion from the requirement to mediate or arbitrate disputes between sellers and buyers for matters within the jurisdiction of Small Claims Court, which includes any claim of damages for $10,000 or less if the plaintiff is an individual, and $5,000 or less if the plaintiff is an entity. The parties are not obligated to mediate or arbitrate these disputes and can go directly to Small Claims Court.

ATTORNEY-CLIENT PRIVILEGED COMMUNICATION. Do not forward to Sellers, Buyers or third parties. This Broker Alert is for the exclusive use of clients of Broker Risk Owners and Management. It may not be reproduced or distributed without the express written consent of Broker Risk Management. The advice and recommendations contained herein are not necessarily indicative of standards of care in the industry, but rather are intended to suggest good risk management practices