What happens to my real estate or other contract as a result of COVID-19?

Contracts in General

Over the past several weeks, we have seen an influx of calls about the impact of the pandemic on contracts. The essential issue is whether parties to a contract can have their performance excused, or at least modified, given the governmental restrictions put in place as a result of COVID-19.

With court operations limited mostly to criminal matters (see our page regarding court closures here), we found no reported California cases giving guidance on this issue. But the circumstances are not altogether different than what happened during WWII. Here is a case example that provides at least some guidance for those who are seeking relief from a contract due to governmental shelter-in-place orders:

In 1941, a car dealership leased a Beverly Hills property for the purpose of selling new cars. Four months later, the federal government discontinued the sale of new automobiles except to those engaged in military activities. Having lost 90% of its business as a result of the government’s orders, the car dealership asked the court to excuse its performance under the lease due to “commercial frustration.”

“The doctrine of frustration depends on the total or nearly total destruction of the purpose for which, in the contemplation of both parties, the transaction was entered into.” (Lloyd v. Murphy (1944) 25 Cal.2d 48, 53.) California has a statute that excuses performance of a contract under such circumstances. Cal. Civ. Code § 1511 (“performance of an obligation … is excused” when, among other circumstances, the performance is “prevented or delayed by an irresistible, superhuman cause, or by the act of public enemies of this state or of the United States”).

“The question in [these] cases is whether the equities of the case, considered in the light of sound public policy, require placing the risk of a disruption or complete destruction of the contract equilibrium on defendant or plaintiff under the circumstances of a given case,” (Lloyd v. Murphy (1944) 25 Cal.2d 48, 53-54.) To be excused from a contract, it is not sufficient to merely show that the “laws or other governmental acts” have made performance “unprofitable or more difficult or expensive.” (Lloyd v. Murphy (1944) 25 Cal.2d 48, 55.)

Applying these principles, the California Supreme Court refused to excuse the car dealership’s performance under the lease. The notable reasons were as follows: (a) at the time the lease was signed, it was reasonably foreseeable that car sales would be restricted because war was on the horizon; and (b) while 90% of its business was lost, the dealership could still operate and earn revenues.

As this opinion suggests, it is not an easy task to escape performance of a contract, even in the challenging times we face today. This is not to say it is impossible, and contracting parties are urged to consult an attorney about their specific circumstances.

Real Estate Contracts

One area in which we have had numerous questions, and several cases, is real estate contracts. In the wake of the COVID-19 outbreak, the real estate market has been pushed into a state of upheaval similar to the 2008 “Great Recession.” Cancellations of purchase contracts have spiked, resulting in disputes generated over deposits. Many situations have arisen as a direct result of COVID-19, such as job losses and changes in investment values and payouts, where buyers are unable to qualify for loans.

We are seeing buyers attempting to get out of contracts and sellers doing what they can to close escrow. There are many instances of buyers sending cancellations, stating the contract is cancelled due to COVID-19—an unforeseen circumstance. Prior to COVID-19, the real estate market was robust. Buyers were submitting multiple offers on properties and often without contingencies. In these instances, if the liquidated damage provision in the purchase agreement is initialed by the parties, the buyer’s deposit could be at risk. Unfortunately, COVID-19 and the attendant impact on the national economy has flipped the market on its ear, and buyers and sellers alike are scrambling to mitigate the impact on property sales and purchases.

A buyer who refuses to perform or attempts to cancel a contract commits a breach of contract or an anticipatory repudiation of the contract. The reasons for cancellation will have an impact on the ability to legally cancel without putting a deposit at risk. If the reason given for cancellation is the buyer’s inability to perform (due to COVID-19 for example), the buyer’s deposit could be at risk.

The liquidated damages provision provides that the seller’s remedy for the buyer’s breach is the deposit. California Civil Code presumes the liquidated damages provision is valid; however, the law allows a buyer to rebut the presumption by showing that the deposit amount was unreasonable at the time the contract was made. To this end, the law allows the buyer to look at facts and circumstances, including any subsequent sale of the property within the coming months.

Prior to COVID-19 and the generally rising market, when buyers were unable to perform, we were seeing sellers simply sell to another buyer for more money. In these situations, the original buyers had an easier time showing the liquidated damages were unreasonable because the sellers did not suffer any damages. Now, however, in what appears to be a decreasing market, we do not see sellers obtaining offers near the original sale price from a defaulted contract. The future is uncertain, but, according to media reports, it will take some time for real estate prices to rise to the pre-COVID-19 values.

From the sellers’ perspective, the amount of the deposit is not going to make them whole. Sellers are remarketing properties, and, obviously, with the Shelter-in-Place order, they do not have the ability to aggressively market them. And, potential buyers are concerned about the ability to close or are waiting to see if the market decreases further.

We are now seeing sellers upset that they initiated the liquidated damages provision in the first place. Assuming the liquidated damages provision is not initialed, the measure of damages could be the difference in value between when a buyer entered into contract and the value at the time of breach. In this market, it is difficult to predict the difference in value. Arguably, with market values decreasing, the value would be more than the deposit, which does not exceed three percent of the purchase price.

To assist, the California Association of Realtors created a Coronavirus Addendum. The Coronavirus Addendum does not automatically entitle a buyer to cancel a contract and obtain a return of the deposit if he/she cannot close. The Coronavirus Addendum, however, does offer various options allowing a buyer to cancel the contract. This may provide a buyer more rights than contemplated in the purchase contract. Sellers are not required to sign this Coronavirus Addendum.

In the end, if buyers want to cancel, or if sellers want to resist cancellation, we suggest they consult with an experienced real estate attorney. The contract and the circumstances of the transaction may provide an avenue to cancel without jeopardizing the deposit. It is also important for sellers to meet with qualified real estate attorneys to determine their rights and to ensure any cancellation was conducted properly to obtain the deposit or actual damages. We, at Rossi Domingue LLP, have over 75 combined years of legal real estate experience in the Bay Area. We successfully represent countless buyers and sellers of residential and commercial real estate, understand the simplest and most complex contracts and the unique markets of our surrounding counties. We want to help protect your most valuable investments and assets—your real estate.