Liquidated Damages & Earnest Money: Civ. Code §1675

TL;DR

When a buyer defaults on a California residential purchase, how much of the deposit the seller may keep is governed by Civil Code §1675 and the formalities in §1677 and §1678. The general rule for liquidated damages in most contracts is Civil Code §1671 — a clause is valid unless the party challenging it proves it was unreasonable. Section 1675 CHANGES that default for residential real property by adding a 3 PERCENT threshold that controls who bears the burden of proof. Under §1675(c), if the amount actually paid does not exceed 3 PERCENT OF THE PURCHASE PRICE, the provision is valid to the extent payment was actually made UNLESS THE BUYER establishes that the amount is unreasonable as liquidated damages. Under §1675(d), if the amount actually paid EXCEEDS 3 percent, the provision is INVALID unless the party seeking to uphold it — in practice the seller — establishes that the amount actually paid is reasonable. The 3 percent figure is therefore not a hard cap; it is a burden-shifting line. Section 1675(b) adds that the clause is valid only to the extent payment in the form of cash or check, including a postdated check, was ACTUALLY MADE, and only if the provision satisfies §1677 and §1678. Section 1677 requires that the liquidated damages provision be SEPARATELY SIGNED OR INITIALED by each party and, if contained in a printed contract, set out in at least 10-point bold type or in contrasting red print in at least 8-point bold type. A clause that fails these formalities is voidable by the buyer, not automatically void.

Why residential purchases have a special rule

A liquidated damages clause fixes in advance what a party will owe if it breaches, sparing the parties a later fight about actual damages. California's general rule appears at Civil Code §1671: outside certain consumer contexts, such a provision is valid unless the party seeking to invalidate it establishes that it was unreasonable under the circumstances existing at the time the contract was made.

Residential real property gets its own regime because the buyer's deposit is often the single largest sum a consumer will ever place at risk on a contract, and because the seller controls the form contract. Civil Code §1675 and following apply to a contract to purchase and sell RESIDENTIAL PROPERTY. The term is narrower than it sounds: for §1675 purposes, residential property means real property primarily consisting of a DWELLING WITH NOT MORE THAN FOUR RESIDENTIAL UNITS, where the BUYER INTENDS TO OCCUPY the dwelling or one of its units as a residence. A purchase of a larger apartment building, or an investor purchase with no intent to occupy, falls outside §1675 and is analyzed under the general rule in §1671 instead. A special statutory rule also applies to certain initial sales of newly constructed attached condominium units in larger structures, but the ordinary exam rule is unchanged: 3 percent is a burden-shifting threshold, not a flat cap. Courts have been explicit about whose interests the scheme serves: in Guthman v. Moss (1984) 150 Cal.App.3d 501, the court observed that the purpose of enacting sections 1675 et seq. was to protect BUYERS who fail to complete the purchase of real property — not sellers. That orientation explains most of the details that follow. For the writing requirement that governs the underlying purchase agreement itself, see our guide to the statute of frauds for real property.

The 3 percent line and who carries the burden

The single most tested feature of §1675 is that 3 percent is a BURDEN-SHIFTING threshold rather than an absolute ceiling. Both subdivisions turn on the amount ACTUALLY PAID.

At or below 3 percent — §1675(c). If the amount actually paid pursuant to the liquidated damages provision does not exceed 3 percent of the purchase price, the provision is valid to the extent that payment is actually made, unless THE BUYER establishes that the amount is unreasonable as liquidated damages. The clause is presumptively good, and the buyer must affirmatively prove unreasonableness to defeat it.

Above 3 percent — §1675(d). If the amount actually paid exceeds 3 percent of the purchase price, the provision is INVALID unless the party seeking to uphold it establishes that the amount actually paid is reasonable. The presumption flips. The seller who wants to keep the larger sum must carry the burden of proving reasonableness.

The practical lesson for drafting is straightforward. In a residential sale, keeping total liquidated damages at or below 3 percent of the purchase price secures the statutory presumption of validity. Going above it is permitted, but it surrenders the presumption and puts the seller to its proof. This is why the standard California form agreement pairs a liquidated damages clause with a 3 percent reference.

Only amounts actually paid count

Section 1675(b) contains a limitation that is easy to miss and frequently tested. The provision is valid only to the extent that payment IN THE FORM OF CASH OR CHECK, INCLUDING A POSTDATED CHECK, IS ACTUALLY MADE, and only if the provision satisfies the requirements of §1677 and §1678 and either subdivision (c) or (d).

Two consequences follow. First, if a contract recites a deposit that the buyer never actually delivered, the seller cannot enforce that phantom amount as liquidated damages — there is nothing to retain and no liability created merely by the recital. Second, the 3 percent analysis is run against what was actually paid, not against what the contract said the deposit would be. A buyer who contracted for a 5 percent deposit but delivered only 2 percent is assessed under §1675(c), because the amount actually paid is what the statute measures.

The §1677 formalities

Even a perfectly reasonable amount fails if the clause is not properly executed and formatted. Section 1677 imposes two requirements on a residential liquidated damages provision:

Separate signature or initials. The provision must be SEPARATELY SIGNED OR INITIALED by each party to the contract. A general signature at the end of the agreement is not enough; the liquidated damages clause needs its own affirmative assent, which is why California purchase agreements place initial lines directly beside the clause.

Type and prominence. If the provision is contained in a printed contract, it must be set out in at least 10-POINT BOLD TYPE, or in contrasting red print in at least 8-POINT BOLD TYPE.

Section 1678 adds further requirements for residential transactions. Failure to satisfy these formalities is a common ground for defeating a seller's retention of a deposit, and many California earnest money disputes turn on nothing more than whether the initial lines were completed. Because a licensee often holds the deposit pending close, the handling rules interact with the trust fund requirements covered in our guide to broker trust fund handling.

Voidable, not void — the Guthman rule

A subtle but frequently tested point concerns the CONSEQUENCE of a §1677 defect. In Guthman v. Moss (1984) 150 Cal.App.3d 501, the buyers — seeking to LIMIT their exposure to the deposit amount — argued that a liquidated damages clause was valid, while the sellers, whose damages exceeded the deposit, argued it was invalid because it had not been separately signed as §1677 requires. The court reasoned that the formal requirements exist to protect buyers, so a failure to meet them does not render the clause automatically void; it renders the clause VOIDABLE BY THE BUYER.

That asymmetry follows the statute's protective purpose. The buyer may disavow a defective clause; the seller may not use its own drafting failure as a sword to escape a liquidated damages ceiling and pursue larger actual damages. In Allen v. Smith (2002) 94 Cal.App.4th 1270, the court likewise held that a liquidated damages clause in a residential contract is enforceable only to the extent it complies with §1675, and the sellers there breached by failing to refund the portion of the deposit exceeding the statutory limit.

Frequently Asked Questions

Is 3 percent a hard cap on liquidated damages in a California residential sale?

No. Three percent is a burden-shifting threshold, not an absolute ceiling. Under §1675(c), if the amount actually paid does not exceed 3 percent of the purchase price, the provision is presumed valid and the BUYER must establish that it is unreasonable. Under §1675(d), if the amount actually paid exceeds 3 percent, the provision is invalid unless the party seeking to uphold it establishes that the amount is reasonable. A seller may retain more than 3 percent, but only by proving reasonableness.

What formalities must a liquidated damages clause satisfy?

Under Civil Code §1677, the provision must be SEPARATELY SIGNED OR INITIALED by each party, and if it is contained in a printed contract it must be set out in at least 10-point bold type or in contrasting red print in at least 8-point bold type. Section 1678 imposes additional requirements for residential transactions. A general signature at the end of the purchase agreement does not satisfy §1677 — the clause needs its own separate assent, which is why form agreements place initial lines beside it.

What happens if the clause was not separately initialed?

Under Guthman v. Moss (1984) 150 Cal.App.3d 501, a clause that fails the §1677 formalities is VOIDABLE BY THE BUYER rather than automatically void. The requirements were enacted to protect buyers, so the buyer may disavow a defective clause, but a seller cannot rely on its own drafting failure to escape the liquidated damages ceiling and pursue larger actual damages instead. If the clause is successfully avoided, the seller's recovery is generally limited to actual damages, which the seller must prove.

Can a seller keep a deposit that the buyer never actually delivered?

No. Section 1675(b) makes the provision valid only to the extent that payment in the form of cash or check, including a postdated check, is ACTUALLY MADE. If the contract recites a deposit that was never delivered, there is nothing for the seller to retain and the recital alone does not create liability for that amount. For the same reason, the 3 percent analysis is measured against the amount actually paid rather than the amount the contract said would be deposited.

How does §1675 relate to the general liquidated damages rule in §1671?

Civil Code §1671 states the general rule: in most contracts a liquidated damages provision is valid unless the party seeking to invalidate it establishes that it was unreasonable under the circumstances existing when the contract was made. Section 1675 modifies that default specifically for residential real property purchases by introducing the 3 percent threshold and the burden-shifting structure in subdivisions (c) and (d), together with the formalities in §§1677 and 1678.

Does the buyer forfeit the deposit for cancelling during a contingency period?

Generally no. Liquidated damages come into play on the buyer's FAILURE TO COMPLETE THE PURCHASE in breach of the contract. A buyer who cancels for cause while a contingency is still active is exercising a contractual right rather than breaching, and is typically entitled to return of the deposit. The liquidated damages analysis under §1675 assumes a buyer default; it does not convert a valid contractual cancellation into a forfeiture.

Bottom Line

California residential liquidated damages are governed by Civil Code §1675, with formalities in §§1677 and 1678, against the general backdrop of §1671. The 3 PERCENT figure is a BURDEN-SHIFTING threshold, not a cap: under §1675(c), an amount actually paid at or below 3 percent of the purchase price is presumed valid unless THE BUYER proves it unreasonable; under §1675(d), an amount above 3 percent is presumed invalid unless the party upholding it proves it reasonable. Section 1675(b) limits the clause to amounts in cash or check, including a postdated check, that were ACTUALLY PAID — a recited-but-undelivered deposit is unenforceable, and the 3 percent test runs against what was actually paid. Section 1677 requires the clause to be SEPARATELY SIGNED OR INITIALED by each party and, in a printed contract, set in at least 10-point bold type or contrasting red print in at least 8-point bold type. Under Guthman v. Moss (1984) 150 Cal.App.3d 501, a clause failing those formalities is VOIDABLE BY THE BUYER rather than void, because the statutory scheme exists to protect buyers; Allen v. Smith (2002) 94 Cal.App.4th 1270 confirms enforceability only to the extent of §1675 compliance and requires refund of the excess. For the exam, remember: 3 percent shifts the burden, only amounts actually paid count, the clause must be separately initialed, and defects are the buyer's to assert. For related topics, see our guides to the statute of frauds for real property, broker trust fund handling, and the Transfer Disclosure Statement.

Source: California Civil Code §1675 — Liquidated Damages, Residential Property (full text) · Cal. Civ. Code §1675 — annotated text and subdivisions · California Civil Code §1677 — Separate Signature and Type Requirements