Liquidated Damages

Liquidated damages are an amount the parties agree on in advance as the payment owed if one side breaches the contract. In home sales, the clause usually names the buyer's earnest money as the seller's compensation if the buyer defaults.

If a buyer with $10,000 down on a $500,000 home backs out without a valid reason, a liquidated damages clause typically lets the seller keep that $10,000 and limits the seller to it. That spares both sides from proving the seller's actual losses in court.

Some states cap or test these clauses. In California, Civil Code section 1675 treats an amount up to 3% of the price as presumptively valid for a home of up to four units the buyer intends to live in; above 3%, the seller must show the amount is reasonable. See can you get earnest money back if you back out.