What follows is our general observations and opinions. It is not legal advice, and it is not a definitive statement of California law. Every situation depends on its own facts.
Somewhere in the residential purchase agreement you initialed is a short paragraph about liquidated damages. Most buyers initial it in the same motion as everything else. It is the provision that decides what happens to your deposit if you do not close, and our reading of California law is that it does two things at once: it caps what the seller can keep, and it forecloses the argument that they should get less.
The headline number is three percent. As we read Civil Code section 1675, on the purchase of residential property of not more than four units where the buyer intends to occupy it, a liquidated damages provision is presumptively valid where the amount does not exceed three percent of the purchase price. Above that figure the presumption flips and the seller generally has to justify the amount as reasonable. That is the rule people have heard of, and it is broadly right — but the conditions attached to it are where the actual outcomes live.
The initials are not decoration
The liquidated damages provision in the standard California residential form is generally only operative if both parties separately initial it. Not signing the contract — separately initialing that specific paragraph. Where a deposit is to be held in escrow, our reading is that the parties also need a separately signed or initialed instruction for its release.
The consequence of missing initials is frequently the opposite of what people assume. Without an operative liquidated damages clause, the seller is not automatically entitled to keep the deposit — but neither is the buyer protected by the three percent cap. The seller is thrown back on proving actual damages, which in a rising market may be nothing at all, and in a falling market may substantially exceed three percent. Whether the clause helps you depends entirely on which direction the market moved after you walked.
Contingencies come first, and they do most of the work
Before any of this matters, the question is whether the buyer was still within a contingency. A buyer who cancels during an active inspection, loan or appraisal contingency is ordinarily entitled to the deposit back, and liquidated damages never come into it.
Most disputes we see are not really about the three percent rule. They are about whether a contingency had been removed. On the standard California form, contingencies generally do not expire on their own — they remain until the buyer delivers a written removal, or until the seller serves a notice to perform and the buyer fails to respond within the stated period. Buyers routinely believe a contingency lapsed automatically when it did not, and sellers routinely believe a deadline passing removed it when no notice was ever served.
The practical lesson is that the paperwork trail around contingency removal decides more deposit disputes than the liquidated damages paragraph does.
What the cap does and does not cover
Where an operative clause applies and the buyer defaults after contingencies are removed, the deposit up to three percent generally becomes the seller’s exclusive remedy for that failure to complete the purchase. The seller does not get to keep the deposit and separately sue for the difference on a later resale.
A few things sit outside it, and they are worth knowing:
- More than three percent was deposited. The excess above three percent is not automatically forfeited. Our reading is that the seller would have to justify the larger figure as reasonable under the circumstances at the time of contracting.
- Not an owner-occupied one-to-four unit purchase. Investment purchases, larger multifamily and land sit outside the section 1675 presumption and are generally analyzed under the ordinary reasonableness standard in Civil Code section 1671.
- Claims that are not about failing to close. Damage to the property during a rent-back, or a breach of a separate obligation, is a different claim.
- The seller’s own default. A liquidated damages clause running against the buyer says nothing about what the buyer can pursue if the seller is the one who walks.
Getting the money out of escrow is its own problem
This is the part that surprises people most. Being right about entitlement does not release the funds. Escrow will generally not disburse a disputed deposit without mutual written instructions or a court order, which means a stalemate can hold the money for months while both sides are convinced the answer is obvious.
The standard California residential form typically requires the parties to attempt mediation before filing, and provides that a party who refuses a proper mediation request may forfeit the right to recover attorney fees even if it later prevails. On a deposit dispute that fee provision frequently matters more than the merits, because the sums in dispute are often comparable to the cost of litigating them. Our advice is usually to make a proper mediation request early and in writing, whichever side you are on.
California also provides a mechanism under which a party who wrongfully refuses to release a residential deposit can face a penalty in addition to the deposit itself. We would not treat that as a routine outcome, but it is a reason not to sit on funds you have no real claim to.
The Los Angeles angle
Three percent of a Los Angeles purchase price is a substantial sum, and deposits here are frequently structured above that figure to make an offer competitive. A buyer who put down five percent to win a bidding war should understand that the portion above three percent is in a different legal position from the rest, and that the standard clause does not simply forfeit it.
Non-standard forms also turn up more often than they should — builder contracts, off-market deals papered by a principal rather than a broker, and probate or trust sales. Those frequently contain liquidated damages language that does not track the statutory framework at all, and they are worth reading closely before any money moves.
How we work on these
Reviewing a purchase agreement, advising on contingency removal, or papering a cancellation is hourly or flat-fee work, and we generally quote a flat fee for a defined review. Where a deposit dispute becomes contested and has to be litigated or arbitrated, that is handled under a separate written fee agreement setting out the arrangement for that matter. No outcome is ever guaranteed, and past results do not predict future results.
If a deal is falling apart and the deposit is in dispute, call us early rather than after the positions have hardened. (310) 556-9692.
Related reading: our real estate resource page, plus what an “as-is” sale does and does not protect, what the Transfer Disclosure Statement requires, and our companion piece on liquidated damages clauses in commercial contracts.
These are our general observations and opinions only. They are not legal advice and not a definitive statement of California law, every situation turns on its own facts, and reading this does not create an attorney-client relationship between us.
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