Why Investors Should Consider Liquidated Damages as an Exit Strategy
Investment deals come with more risk than residential purchases and sales (on average). The unpredictability of investment deals, from title issues, to absentee sellers, to no guaranty of your investment, leave investors feeling a need to have exit strategies in place at as many junctures as possible. At our firm, we strive to mitigate these risks through a specialized service for legal underwriting and with our contract drafting. One of the exit strategies we use is a liquidated damages clause.
A liquidated damages clause serves as a critical risk management tool. By setting a predetermined amount for damages in the event of contract breach, it caps potential losses and provides a straightforward resolution, avoiding the complexities and costs associated with court proceedings. Such clauses are generally upheld by courts, provided they are reasonable in light of potential losses and equitable given the bargaining power of both parties. This ensures that the clause is neither excessively burdensome nor trivially lenient.
What is a liquidated damages clause and what does it look like?
Liquidated Damages is a clause that sets a particular amount to be given to the non-breaching party in the case of a breach of the contract and the language will look like this:
The Seller has the right to retain the Buyers’ deposit in the amount of $5,000 as liquidated damages in the case of the Buyer breaching the contract of sale. By accepting liquidated damages the Seller waives their right to pursue the Buyer for monetary or equitable damages unless they need to enforce this particular provision of the contract of sale.
Why would an Investor choose to use this strategy?
For investors, adding a liquidated damages clause is strategically valuable. It provides clarity and predictability, allowing for better risk assessment. It also helps you to measure your exposure across your entire pipeline (if you are managing multiple deals). The certainty of knowing your maximum liability enables you to manage your investment portfolio more effectively, assessing risks and rewards with a clear understanding of potential financial outcomes if in the worst case of the transactional scenario, you have to back out and you don’t have the right to back out under the contract of sale.
Moreover, adopting a liquidated damages clause can be a mutually beneficial strategy, safeguarding both parties against having to go to court while securing a measure of compensation (the liquidated damages amount) that is agreeable to both. In practicality both parties are usually equally unhappy. Foresight in contract drafting is one of the unique qualities of our firm.
How much should the liquidated damages be?
Effective contract drafting involves striking the right balance between a few factors when setting liquidated damages. This is not about finding a middle ground but rather choosing a figure that aligns with the anticipated or actual loss, thus avoiding the label of punitive damages, which are unenforceable. When a breach occurs, the clause enables the seller to claim the stipulated amount directly, bypassing the need for litigation and allowing both parties to conserve resources and continue their endeavors without further dispute.
Beware – One important thing to remember is that if you DO NOT honor the liquidated damages clause and agree to the release of the funds in the case of your breach OR if you feel that you didn’t breach the contract and the issue of breach becomes contentious, you could face a lawsuit, so as always, while this post is intended to support you from an educational perspective, it is important to hire a real estate attorney to represent you on your investment deals so they can help you navigate the apparent nuances.
At Molson Law Firm, we understand that each investment presents unique challenges and opportunities. Our approach is tailored to meet the specific needs of our clients, ensuring that they are equipped with the best legal strategies to protect their interests. We encourage prospective clients to reach out and discuss how we can support your investment goals with robust legal solutions. Contact us today to learn how our expertise can enhance your investment business and let’s discuss how we can can work together on your next deal.
This post is for educational purposes only and does not create an attorney client privilege between the reader and Molson Law Firm, LLC.
