Coastal San Diego · Buyer and seller guides · Deposits when a deal falls through

What liquidated damages mean when a home sale falls through

Short answer: Liquidated damages are a written contract clause. They can let a seller keep all or part of a buyer’s deposit (money held in escrow, the neutral company that holds money and papers) if the buyer backs out without a right to cancel — but only when the clause is properly turned on and California law allows it. Two sections of the California Civil Code (the state’s main book of contract and property laws), §1675 and §1677, set the main limits. Your signed purchase agreement controls. This is not legal advice.

When a deal breaks, people ask me the same thing: does the seller keep the deposit, or does the buyer get it back? The answer often turns on whether a liquidated-damages clause was turned on, and on what the Civil Code allows.

This page is for buyers and sellers in coastal San Diego. It explains the written clause in plain words. It is process only. It is not legal advice, and it is not advice about any one deal.

I’m Weston Clark, Founding Member of the Dickinson-Clark Team at Compass. I help buyers and sellers in coastal San Diego read the deposit and liquidated-damages words in their signed papers before a fight starts. You can talk about fees with Weston directly. This form does not give a commission quote.

Talk to Weston Jump to FAQ Cancel rights (contingencies)

Related: Cancel rights · Notice to perform · Good-faith deposit · Request for repair · Escrow · Guides · When a sale falls through

What liquidated damages are

In a home sale, liquidated damages are a written deal about what the seller may keep as damages if the buyer fails to finish the purchase. That is not the same thing as the deposit itself. The deposit is the money held by escrow (the neutral company that holds money and papers). The liquidated-damages clause is the contract language that may let the seller keep some or all of that money when the buyer breaches. “Breach” (you will also hear “default”) just means one side did not do what the signed contract says, for example a buyer who walks away after giving up their cancel rights.

The California Department of Real Estate (DRE) says that if both seller and buyer separately sign or initial the liquidated-damages paragraph, it is turned on. If the seller then proves the buyer breached, the DRE describes two main results. First, the seller is released from the duty to sell to that buyer. Second, the liquidated-damages amount is limited to the buyer’s deposit, up to 3% of the purchase price.

Your signed purchase agreement and any separate liquidated-damages papers control. Escrow follows written instructions it is allowed to follow — see my escrow guide. Cancel windows while contingencies are still open are in my contingencies guide.

What California Civil Code says

The California Civil Code is the set of state laws that covers contracts, including home purchase contracts. Section 1675 (written “§1675”) is the part about liquidated damages in home sales. It covers many home sales of not more than four units when the buyer plans to live there. The statute calls that “residential property.”

Quote from Civil Code §1675(c): “If the amount actually paid pursuant to the liquidated damages provision does not exceed 3 percent of the purchase price, the provision is valid to the extent that payment is actually made unless the buyer establishes that the amount is unreasonable as liquidated damages.”

In plain words: when the amount paid under the clause is 3% of the price or less, the clause usually stands unless the buyer shows that amount is not fair.

Quote from Civil Code §1675(d): “If the amount actually paid pursuant to the liquidated damages provision exceeds 3 percent of the purchase price, the provision is invalid unless the party seeking to uphold the provision establishes that the amount actually paid is reasonable as liquidated damages.”

Above 3%, the burden flips. The side trying to keep the higher amount must show it is fair.

Civil Code §1677 says the clause is invalid unless each party separately signs or initials it. If it is in a printed contract, it must be in at least 10-point bold type, or in contrasting red print in at least eight-point bold type.

Civil Code §1678 covers later payments, such as an increased deposit. Each later payment meant to be liquidated damages needs its own separately signed or initialed clause. The total must still meet §1675.

The DRE matches that idea. If the deposit went up after the first offer or acceptance, and the increase is meant to be liquidated damages, both sides must sign a separate liquidated-damages agreement for the increase.

Deposit vs. liquidated-damages clause

People mix these up. Earnest money (the good-faith deposit) is the cash or check that goes into escrow after acceptance. It usually counts toward the purchase price if the sale becomes final. A liquidated-damages clause is the separate agreement about what happens to that money if the buyer fails to finish the purchase when the seller has a right to damages.

Having a deposit in escrow does not automatically mean the seller keeps it. The DRE ties the seller’s path to a turned-on clause and proof of buyer breach. Escrow release of funds usually needs written instructions from both sides (or another clear path your contract allows). Ending a deal and deciding who gets the deposit are not always the same step.

While a contingency (a written cancel right) is still open and the buyer cancels the way the contract allows, the deposit is usually returned. Once contingencies are removed in writing, the file looks different. Ask your own attorney about your papers.

When this usually comes up

It comes up when a buyer has removed cancel rights (or never had them) and then fails to finish the purchase. It also comes up when the seller claims the buyer breached after a notice-to-perform path. And it comes up when someone treats an increased deposit as liquidated damages without a separate signed clause.

It is not the same as a repair talk after the inspection. A request for repair is a written ask. Liquidated damages are about what happens to the deposit when the buyer does not follow through, and the limits state law and your signed clause put on that.

I cannot promise who keeps a deposit, how fast a dispute ends, or what a court or mediator would do. Put every important step in writing. Get advice the same day someone says the other side broke the contract.

What to do if this is in your contract

• Find the liquidated-damages paragraph (or separate agreement). Check whether both sides initialed or signed it separately.
• Note the deposit amount actually paid into escrow. Check whether any later increase has its own liquidated-damages paper.
• Read Civil Code §1675 and §1677 with your attorney if someone says the buyer broke the contract. The 3% line and the separate-initials rule matter.
• Keep escrow copied on signed papers. Phone calls do not replace the written file.
• If you received or need to send a notice to perform about a missed step, treat that as its own written clock. Do not mix it with a repair ask.

Buyers: removing contingencies in writing changes your deposit risk. Sellers: a turned-on clause still has Civil Code limits. Do not assume you keep every dollar without advice.

General information only

This guide explains the liquidated-damages idea used in many California home sales. It is not legal advice, tax advice, or advice about any one contract. Your signed agreement controls. Ask your own attorney about your rights. Housing opportunities are open to everyone under fair housing law.

More on sandiego.homes

• Cancel rights: the windows that often decide whether a deposit comes back
• Notice to perform: the written clock when a step is overdue
• Good-faith deposit: the money in escrow the LD clause may reach
• Request for repair: the written inspection ask that is negotiation, not a deposit fight
• Final walk-through: the last look near closing, separate from who keeps a deposit
• Escrow: how deposits are held and released on signed instructions
• Offer strategy: how the deal and deposit were shaped at acceptance
• Multiple offers: when deposit size and clause language get attention
• What sellers must tell you: required notices that sit beside contract clocks
• As-is sales: current-condition sales still use deposit and default rules
• Buying and selling: the full path from offer to keys
• Guides: all buyer and seller guides

• More: All guides · Buying and selling · Real estate terms

Talk with Weston about deposits and liquidated damages

Tell me whether you are the buyer or the seller, and whether the liquidated-damages paragraph was initialed. I’ll help you read the next written step with your papers in hand.

Or call (858) 997-8998 · weston@sandiego.homes · Search on Compass

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Have another question? Quick answers to common questions

Sources

• California Civil Code § 1675
• California Civil Code § 1677
• California Civil Code § 1678
• California DRE - Basic Contract Provisions and Disclosures (ref. book ch. 20)
• sandiego.homes - Contingencies
• sandiego.homes - Escrow
• sandiego.homes - Earnest money
• sandiego.homes - Request for repair
• sandiego.homes - Notice to perform