Liquidated Damages

May the seller of a co-op apartment retain the usual 10 percent deposit as liquidated damages after the purchaser's default if so provided in the contract of purchase and sale? The answer was a clear "yes" in Amato v. Hird.

This case involved a motion by plaintiff for summary judgment declaring that she was entitled to the $105,000 deposit made by defendants under a contract entered into in June 2001 between the parties in the lawsuit providing for sale by plaintiff of her rights as a cooperative owner of apartment 18C at 45 East End Avenue.

The contract set a purchase price of $1,050,000 and required a deposit of $105,000, which was to be held in escrow by the attorney who handled the purchase for the defendants subject to further order of the court.

Paragraph 13.1 of the contract provided: "In the event of a default . . . by Purchaser, Seller's sole remedy shall be to terminate this contract and retain the contract Deposit as liquidated damages...In case of Purchaser's . . .default, Seller's damages would be impossible to ascertain and the contract Deposit constitutes a fair and reasonable amount of compensation."

The closing was scheduled to occur "on or about September 24, 2001." Since the defendants were not interviewed by the cooperative by that date, the closing did not then occur. On October 2, the defendants were interviewed by two members of the cooperative board, and the board subsequently approved the purchase by defendants.

However, on October 3, 2001, the defendants sent a letter to their lawyer, which apparently was also sent to plaintiff, in which they stated:

"We regret to inform you that we have decided not to proceed with our purchase of Apartment 18C at 45 East End Avenue, and we hereby request that the contract for the purchase of that apartment be canceled...Please be assured that we are very disappointed with this outcome and are not taking this step lightly and without having given it careful consideration."

The only reason ascribed by defendants for the cancellation was that the cooperative approval process had been delayed over the summer and that at the interview on October 2, "two persons only were present, reducing the entire long process to a total farce."

The next day, October 4, the plaintiff sent a letter to the defendants' counsel stating that, "the reasons set forth in [defendants'] October 3 letter for attempting to cancel the sale are insufficient [and] I therefore demand that you immediately send me forthwith the full amount of the contract deposit, plus accrued interest."

In the complaint, the plaintiff sought a declaration that she was entitled to have the contract deposit paid to her. In their counterclaims, the defendants sought a declaration that they were entitled to the return of the deposit.

The defendants' letter of October 3 clearly set forth a choice not to proceed with the purchase. In light of such repudiation, there was no need for the plaintiff to arrange a closing since the defendants "had canceled the contract, there was no necessity for the vendee to tender performance, as a vain act is not required."

The court said that defendants offered no valid excuse for their cancellation. In the court's view, an interview of a prospective purchaser by only a committee of a cooperative board was common and here the full board approved the purchase promptly after the interview of October 2. The liens of existing mortgages also failed to provide a valid excuse for the cancellation as the amounts of the liens were significantly lower than the amount of the purchase price and the plaintiff had shown that she had obtained "payoff" statements from the mortgagee. Thus, the court concluded that defendants were in breach of the contract.

The remaining issue before the court was whether, because of such breach, the plaintiff was entitled to recover the full 10 percent contract deposit. With respect to real estate contracts, the court said that it had been said that for "more than a century it has been well settled in this State that a vendee who defaults on a real estate contract without lawful excuse cannot recover the down payment." However, a contract for the sale of an interest in a cooperative apartment, "in reality a sale of securities in the cooperative corporation, is governed by the Uniform Commercial Code."

The issues in two previously decided court of appeals cases did not involve a liquidated damage clause or any claim related to a contract deposit. But, while in one, a case decided before the surge of cooperative ownership in New York City, the issue before the court was whether the seller of rights relating to a cooperative apartment was entitled to retain the contract deposit after a default, in that case the subject contract did not contain a liquidated damage clause.

There, the court held that a contract for both the sale of stock in a cooperative corporation and the assignment of the proprietary lease did not "create a new classification of real estate" and "that the shares of a cooperative stock relative to the proprietary lease... are 'goods' within Article 2 of the Uniform Commercial Code," and the rights of the parties with respect to the deposit are therefore governed by section 2-718 of the code.

Although in the later case, from 1993, held that the dicta in the first case stating that Article 8 of the UCC did not apply to shares issued by a cooperative corporation "has lost its validity over time," that court reaffirmed the holding in the prior case that UCC Article 2 applies "to contracts for the sale of cooperative apartments."

Paragraph (1) of UCC Section 718 provides that the parties may agree to a liquidated damage amount, "but only at an amount which is reasonable in the light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy."

In Wojciechowski v. Birnbaum, the plaintiff contracted to purchase a cooperative apartment for $630,000 and under that agreement made an escrow deposit of $63,500. After the plaintiff failed to close, the defendant sold the apartment to a third party for $625,000. In affirming the trial court's finding that the 10 percent liquidated damage provision was reasonable, the appellate division, first department wrote: " . . .assuming arguendo that this $630,000 contract is governed by UCC Article 2, forfeiture of the deposit cannot be equated with the imposition of a penalty in violation of UCC 2-718, since in the circumstances presented, namely the sale of the apartment some seven months later for $625,000, liquidated damages in the amount of $63,500 cannot be deemed unreasonably large."

Similarly, in Blackman v. Genova, the appellate division, second department, upheld a 10 percent liquidated damage provision in a contract for the sale of a cooperative apartment, finding that the defaulting buyer failed to show "that the amount fixed as liquidated damages was so unreasonably large as to constitute a penalty."

Since the latter case involved a contract for the sale of real estate, citation to that case indicated that the tradition of enforcing a liquidated damage clause of 10 percent of the purchase price in real estate contracts may normally be applicable to contracts for the sale of cooperative apartments.

Other cases dealing with real estate contracts were cited in determining the reasonableness of the period given in a "time of the essence" notice in a contract relating to the sale of a cooperative apartment.

Under the circumstances presented, the court concluded that there was here no basis to find that the 10 percent liquidated damages provision was unreasonable. Thus, it was enforced, with the consequence that the plaintiff seller was granted summary judgment declaring that she was entitled to receive the $105,000 deposit from the escrowee. The defendants' motion was denied.

Comment: Real estate contracts in the New York metropolitan area including co-op purchase and sale agreements normally provide for a 10 percent deposit on account of the purchase price. Invariably, this deposit is held in escrow until the closing when it is paid to the seller. If the sale fails to take place because some contingency in the contract does not occur, the purchaser would normally have his deposit returned. If the sale fails to occur because of the seller's breach, the normal remedy is an action for specific performance to compel the conveyance of a unique piece of real estate. If the sale fails to occur because of the purchaser's breach, the deposit is virtually always retained by the seller as liquidated damages.

This case holds that a 10 percent deposit qualified as liquidated damages and not a penalty. If, in another contract for the purchase and sale of a co-op, there was a provision for a 20 percent deposit, could this also serve as liquidated damages and not a penalty if so specified in the contract? The answer is maybe, as the decision would depend on all of the facts and circumstances that justified an increase in the standard deposit from 10 to 20 percent.