Beyond Specific Performance: Recovering Damages Through Escrow
By: Michael Newhouse, a shareholder in the Litigation Practice Group at Buchalter Nemer and a licensed real estate broker.
A developer who achieves a forced sale through a special performance lawsuit can recover damages as escrow credits.
IT HAPPENS ALL THE TIME: a developer finds a property that is well priced and ideal for his or her next project. The developer has deposited earnest money, cleared contingencies and begun lining up an architect, engineer and subcontractors. But then the seller wants to back out, or wants more money. What does the developer do next?
Too often, the developer’s instinct, typically ratified by a broker or attorney’s advice, is to either accept the higher purchase price as a “cost of doing business” or let the deal go, take back the deposit and move on to another property.
Often, however, there is a good “third option”: a specific performance lawsuit, with a demand that all damages — including attorneys’ fees and costs, encumbrances and lost future rents or profits — be paid directly as escrow credits following a state court-ordered closing.
A sale can be forced through “specific performance” when all of the following conditions are met:
- The buyer has put the seller on notice of its demand. If the seller does not agree to mediation and arbitration, early filing of a specific performance lawsuit can be a strategically powerful opening move.
- The buyer has “substantially performed” its duties under the contract; for example, by depositing earnest money.
- The seller has not performed; for example, if the seller refuses to close escrow.
- The purchase and sale agreement (PSA) terms are sufficiently definite. (Because most parties use standard realtor forms that reasonably and accurately describe the property and terms of purchase, this is rarely an issue.)
- The PSA is reasonable and fairly priced; the adequacy of consideration is determined as of the time the contract was made.
- The terms of the requested “forced sale” are “substantially similar” to the terms of the PSA; they need not be identical.
- The buyer’s “legal remedy” (that is, simply getting a money judgment against the breaching seller) is inadequate.
Regarding the final point, a developer usually can make a strong argument that it is entitled to the presumption that its legal remedy is inadequate. More specifically, the buyer should focus on evidence establishing that it specializes in acquiring the type of property at issue in the suit and improving it for a specific purpose in the marketplace. The buyer should also explain to the court that few properties of the type in question become available for sale, and that even fewer properties specifically fit the buyer’s business model. Thus an award of damages would not be adequate to make the buyer whole in light of the unique opportunities afforded by the property in question.
Damages Paid Through Escrow “Credits”
While there is nothing unusual about obtaining a specific performance judgment when the above factors are satisfied, having the resulting damages deducted directly from the purchase price in escrow is a little known and obviously attractive option for buyers. Having such damages directly paid to the buyer, through one or more of the following three options, removes the single most difficult step in the litigation process, collection.
1) Damages due to liens, taxes and other encumbrances. Where claims or other defects in title exist, a seller may be required to convey his or her interest in the property and the buyer may be compensated for the deficiency in performance. Additionally, most PSAs require that taxes be “paid current” and prorated between the buyer and the seller.
Thus, in addition to an order of specific performance, buyers should ask the court to deduct debts, such as property taxes and judgment liens, from the purchase price or to order them paid and satisfied through escrow.
2) Deducting lost rent or profit damages due to delayed performance. Because a buyer seeking specific performance has lost possession and use of the property during the delay in receiving title, that buyer is entitled to offset from the purchase price lost rents or profits and increased costs caused by the delay. In one 1985 case, the buyer received a $70,000 credit for increased construction costs of $20 per square foot resulting from delay. In a 1986 case, the seller was required to reduce the $1.05 million purchase price by $150,000 because of increased development costs. Such an offset or credit is not a breach of contract damage; it is designed to relate specific performance back to the date escrow was set to close and adjust the equities between the parties that resulted from the delayed performance. To obtain these credits and offsets, no specific pleading is required.
3) Attorneys’ fees. Lastly, buyers should seek all attorneys’ fees and costs associated with the specific performance action. Such fees and costs are, of course, not generally available under statute, but are almost always provided for in the PSA.
In short, before letting a recalcitrant seller off the hook on an otherwise good deal, developers should consider a specific performance lawsuit seeking all damages through a court-ordered closing.
This article is adapted from a “From the Inside” blog piece that appeared in Commercial Property Executive on Jan. 6, 2015.