Liquidated damages clause

If both Buyer and Seller initial the liquidated damages clause, what amount of damages is the Seller entitled to should the Buyer default?

  1. 3% of the earnest money deposit.
  2. The full earnest money deposit.
  3. 3% of the purchase price.
  4. The full earnest money deposit or 3% of the purchase price, whichever is less.

The answer is D.

The Seller is entitled to the full earnest money deposit or 3% of the purchase price, whichever is less.

Remember that the liquidated damages clause is part of the purchase contract – the contract that the buyer fills out in order to put in an offer on a property, and this contract later becomes the escrow instructions if and when the seller accepts the buyer’s offer.

This is probably best illustrated with an example:

Suppose the purchase price of a home is $100,000. The buyer, to show that he’s really serious about his offer, puts in a $5,000 earnest money deposit, which is 5% of the purchase price of the home. The seller accepts the offer and they both initial the liquidated damages clause.

But, let’s say the buyer finds a really good job somewhere in another state, and has to back out of the deal. Now, the seller is entitled to liquidated damages, but how much does he get? Well, the seller will not get the full earnest money because $5,000 is more than 3% of the purchase price – the limit is meant to save the buyer some money in case he put in a really large deposit. So, the seller will get $3,000, or 3% of the purchase price.

You may have mistakenly chosen B. But, if the earnest money deposit is larger than 3% of the purchase price of the property (as in our example above), then it’s obvious that B is incorrect.