July 31, 2014
Earnest Money Deposit as Liquidated Damages
Your typical disputes over an earnest money deposit as liquidated damages in residential real estate sales go something like this: Home buyers decide to submit a contract and an earnest money deposit as an offer to purchase the property. Before closing, the buyer cannot find financing or discovers a defect with the home. If the buyer still has a contingency she can exercise to get out of the contract, then usually there is not a problem with return of the deposit. Where the seller is worried about finding another buyer and there is no applicable contingency, there might be a dispute over who is entitled to the escrowed funds. In scenarios falling within this classic dilemma, the common fact is that the realtor, seller or some other escrow agent holds the buyer’s funds until they are dispersed pursuant to the sales contract.
What if the buyer signs the contract but never submits the deposit and does not go to closing? Can the buyer still be liable to the seller in the deposit amount? The Circuit Court of Fairfax County, Virginia, recently held that contract default language in a National Association of Realtors form was unenforceable as written under this scenario.
In April 2012, Sagatov Builders, LLC entered into a contract to sell Christian Hunt a residential property in Willow Creek Estates in Oakton, Virginia. The contract required Mr. Hunt to submit a $50,000 deposit within 5 days of the issuance of the building permit. The seller submitted the approved building permit to Mr. Hunt in September 2012. According to the Complaint, Mr. Hunt failed to make the deposit or to go to closing. According to Redfin.com, the property was sold on Dec. 13, 2013 for $2,775,000. Perhaps Sagatov suffered some expenses and inconveniences associated with having the property tied up with Mr. Hunt during peak home selling months. Sagatov’s website has an advertisement for the completed property, including pictures and a description. In April 2014, Sagatov Builders filed a lawsuit against Mr. Hunt for the unpaid $50,000.00 deposit as liquidated damages for his breach of the contract.
Why is Sagatov seeking the deposit amount as liquidated damages instead of a calculation of actual damages suffered? The parties used a National Association of Realtors Sales Contract for Land form No. W-48C (VA) dated 6/95. Section 21, entitled, “Default,” provides that:
If the Purchaser is in default, the Seller shall have all legal and equitable remedies, retaining the Deposit until such time as those damages are ascertained, or the Seller may elect to terminate the contract and declare the Deposit forfeited as liquidated damages and not as a penalty …. If the Seller does not elect to accept the Deposit as liquidated damages, the Deposit may not be the limit of the Purchaser’s liability in the event of a default.
On its face, this provision would seem to give the seller the option of retaining the deposit as liquidated damages and/or going after the buyer for additional damages. What are “Liquidated Damages” in Virginia? Attorney Lee Berlik defines them in his blog post as:
[T]he amount of which has been agreed upon in advance by the contracting parties. When a contract contains a liquidated-damages provision, the amount of damages in the event of a breach is either specified, or a precise method for determining the sum of damages is laid out. This is often done in situations where the parties agree that the harm likely to be caused by a breach would be difficult or impossible to measure with any precision, so they agree on a figure in advance and dispense with the time and effort that would otherwise be involved in proving compensatory damages at trial.
Rather than litigating a hot mess of damages issues, parties can stipulate to liquidated damages in their contracts. So long as the liquidated amounts are not deemed a “penalty” by the Court, these provisions are enforceable. A few months ago I posted an article to this blog about how Courts seek to avoid imposing similar penalties in construing commercial lease acceleration of rents provisions.
The liquidated damages provisions in the real estate form that came before Fairfax Circuit Court Judge Charles Maxfield presented a new twist on the liquidated damages vs. improper penalty debate. Upon the buyer’s default, these provisions gave the Seller the option of electing the liquidated damages or seeking some other amount of damages.
Judge Maxfield declared the liquidated damages option in the contract to be unenforceable because:
- It isn’t a true stipulation to liquidated damages because of its elective characteristics; and
- Even if it was, it is a “penalty” because it would only be exercised if actual damages were less than the deposit amount.
I think that the drafters of the form (leaving aside for a moment the changes made by Sagatov and Hunt) contemplated that an escrowed deposit would become a potential source for payment of damages in the event of default. These default terms seem focused on avoiding a scenario where the escrow agent would have to release the deposit, only to watch an aggrieved party chase after those released funds in court. They seem to have tried to create a right to draw on an escrow in the event of a breach.
Virginia Lawyers Weekly reports that Sagatov will have an opportunity to re-draft its pleadings based on the Court’s ruling. It will be interesting if this case ultimately goes up on appeal to the Supreme Court of Virginia.
If the $50,000 deposit had been actually escrowed, would the Court’s interpretation and application of these Default terms be any different? If actual damages were less than $50,000, would drawing the whole amount constitute a “penalty?” What if expenses dealing with the dispute, such as attorney’s fees, were incurred by the seller?
July 24, 2014
Tenancy by the Entirety and Creditor Recourse to Marital Real Estate
Last week I focused on first-time home buyers and new opportunities for state tax-exempt estate planning. This week’s post continues on the theme of family. Spouses who own Virginia property together may enjoy special protections against the claims of their individual creditors. This special form of ownership is called “Tenancy by the Entirety.” For this to arise, the husband and wife must own in unity of (a) time, (b) title, (c) interest and (d) possession. These requirements may be inferred if the deed specifically conveys to the husband and wife by tenancy by the entirety or with an intent to create a right of survivorship.
As far as creditors are concerned, the couple jointly owns an undivided 100% interest. This ancient doctrine continues to be applied by Virginia courts in contemporary real estate controversies. This post focuses on ways creditors may succeed in spite of this manner of holding title:
- Joint Consent. Neither spouse may sever the tenancy by his sole act. Likewise, one spouse cannot convey the property unilaterally. This becomes significant if one spouse attempts to mortgage the property without the consent of the other. However, the spouses may cause the termination of the tenancy by the entirety ownership or jointly liability for a lien or judgment. For example, when the owners take out a mortgage, if properly perfected, that lien will persevere against acts of divorce and/or bankruptcy unless exceptions apply. Also, if only one spouse files for bankruptcy, the tenancy by the entirety property remains outside of the Bankruptcy Estate.
- Divorce. Completion of a divorce transforms a tenancy by the entirety into a tenancy in common, the ordinary form of co-ownership. In equitable distribution, a Judge has considerable latitude in dividing up marital property.
- Death. Because of the right of survivorship, no transfer of title occurs to the survivor upon the death of a spouse. Upon death, the interest of the surviving spouse converts from a tenancy by the entirety to a sole ownership interest. At that time, the property then becomes subject to creditor claims.
- Fraud. If the husband and wife attempt to work a fraud on a creditor by improper use of a tenancy by the entirety conveyance, it is unlikely that the court would permit the fraud. However, if the couple sells real estate held in a tenancy by the entirety, the proceeds of that sale automatically also enjoy the same status as the real estate, unless there is an agreement to the contrary. A transfer from the husband and wife holding in tenancy by the entirety to the sole name of one of the spouses does not subject those funds to the claims of the other spouse’s creditors.
The gist of tenancy by the entirety flows intuitively from the legal understanding of marriage. It possesses a seemingly “magical” quality when it comes to protecting against many individual creditor claims. However, it can be difficult applying the doctrine to a family’s individual circumstances. If you have questions about Tenancy by the Entirety, whether as a spouse or a creditor, contact a qualified attorney.
In Re Eidson, 481 B.R. 380 (Bankr. E.D. Va. 2012) (interpreting Va. law).
Alvarez v. HSBC Bank USA, 733 F.3d 136 (4th Cir. 2013) (interpreting Md. law).
U.S. v. Parr, File No. 3:10-cv-061 (W.D. Va. Oct. 6, 2011) (Moon, J.) (interpreting Va. law).
In Re Bradby, 455 B.R. 476 (Bankr. E.D. Va. 2011) (interpreting Va. law).
In Re Nagel, 298 B.R. 582 (Bankr. E.D. Va. 2003).
July 2, 2014
Attorneys Fees for Rescission of Contracts Obtained by Fraud
In lawsuits over real estate, attorney’s fees awards are a frequent topic of conversation. In Virginia, unless there is a statute or contract to the contrary, a court may not award attorney’s fees to the prevailing party. This general rule provides an incentive to the public to make reasonable efforts to conduct their own affairs to avoid unnecessary legal disputes. An exception to the general rule provides a judge with the discretion to award attorney’s fees in favor of a victim of fraud who prevails in court. Effective July 1, 2014, a new act of the General Assembly allows courts greater discretion to award attorneys fees for rescission of contracts obtained by fraud and undue influence. The text reads as follows:
In any civil action to rescind a deed, contract, or other instrument, the court may award to the plaintiff reasonable attorney fees and costs associated with bringing such action where the court finds, by clear and convincing evidence, that the deed, contract, or other instrument was obtained by fraud or undue influence on the part of the defendant.
This new statute narrowly applies to fraud in the inducement and undue influence claims requesting as a remedy rescission of a written instrument. I expect this new attorney’s fees statute to become a powerful tool in litigation over many real estate matters.
- Obtaining Approval of Written Instruments by Misconduct. This new statute does not focus on the manner or sufficiency of how obligations under a contract or deed are performed. Instead, it concerns remedies where one party obtains the other’s consent on a written instrument by material, knowing misrepresentations made to induce the party to sign (fraud) or abusive behavior serving to overpower the will of a mentally impaired person (undue influence). Fraud and undue influence are usually hard to prove. There are strong presumptions that individuals are (a) in possession of their faculties, (b) are reasonably circumspect about the deals and transfers they make and (c) read documents before signing them. This new statute does not allow for fees absent clear & convincing proof of the underlying wrong. Tough row to hoe.
- Undoing Deals Predicated on Fraud or Undue Influence: This new statute doesn’t help plaintiffs who only want damages or some other relief. The lawsuit must be to rescind the deed or contract that was procured by the fraud or undue influence. Rescission is a traditional remedy for fraud and undue influence, and it seeks to “undo the deal” and put the parties back in the positions they were in prior to the consummation of the transaction. This statute should give defendants added incentive to settle disputes by rescission where a fraud in the inducement or undue influence case is likely to prevail.
- Reasonableness of the Attorney’s Fees Award: When these circumstances are met, the Court has discretion to award reasonable attorney’s fees. Note that the statute does not require that fees be awarded in every rescission case. Under these provisions, on appeal the judge’s attorney’s fees award or lack thereof will be reviewed according to the Virginia legal standard for reasonableness of attorney’s fees.
Prior to enactment of Va Code Sect. 8.01-221.2, defrauded parties had to meet a heightened standard in order to get attorney’s fees. In 1999, the Supreme Court of Virginia held in the Bershader case that even if there is no statute or contract provision, a judge may award attorney’s fees to the victim of fraud. However, in Bershader the Court found that the defendants engaged in “callous, deliberate, deceitful acts . . . described as a pattern of misconduct. . .” The Court also found that the award was justified because otherwise the victims’ victory would have been “hollow” because of the great expense of taking the case through trial. The circumstances cited by the Court in justifying the attorney’s fees award in Bershader show that the remedy was closer to a form of litigation sanction than a mere award of fees. Bershader addressed an extraordinary set of circumstances. Trial courts have been reluctant to award attorney’s fees under Berschader because it did not define a clear standard.
The new statutory enactment removes the added burden to the plaintiff of showing extraordinary contentiousness and callousness or other circumstances appropriate on a litigation sanctions motion. It is hard enough to prove fraud or undue influence by clear and convincing evidence, and then show reasonableness of attorney’s fees. Why should the plaintiff be forced to prove callousness and a threat of a “hollow victory” if fraud has already been proven and the court is bound by a reasonableness standard in awarding fees? The old rule placed a standard for awarding attorney’s fees in fraud cases to a heightened standard comparable to the one available for imposition of litigation sanctions. Va. Code 8.01-221.2 permits attorney’s fees in a rescission case without transforming every dispute in which deception is alleged into a sanctions case.
case citation: Prospect Development Co. v. Bershader, 258 Va. 75, 515 S.E.2d 291 (1999).
photo credit: taberandrew via photopin cc (photo is a city block in Richmond, Virginia and does not illustrate any of the facts or circumstances described in this blog post)