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The issue in the Massachusetts case Kelly v. Marx was whether home sellers could retain the buyers’ deposit when the buyers backed out of the purchase, yet the sellers suffered no damages. In May 1994, John and Pamela Kelly entered into a purchase and sale agreement (the “Agreement”) to purchase the home of Steven and Merrill Marx (the “Sellers”) for $355,000. According to the Agreement, “If the Buyer shall fail to fulfill the Buyer’s agreements herein, all deposits made hereunder by the Buyer shall be retained by the Seller as liquidated damages.” The Kellys’ total deposit was $17,750 - five percent of the purchase price.
The Kellys never purchased the house. On August 9, 1994, they notified the Sellers that they were unable to sell their present home, and to put the house back on the market. On August 24th, the Sellers accepted another offer, and sold the property for $360,000 a few weeks later. The Kellys sued the Sellers for the return of their $17,750 deposit. The Sellers filed a motion for summary judgment, and the lower court held that the Sellers were entitled to keep the deposit pursuant to the liquidated damages clause of the Agreement. The Kellys appealed.
The Appeals Court reversed the lower court decision and ordered the Sellers to return the deposit to the Kellys. That court based its decision on the “second look” doctrine, under which it concluded that the Sellers were not entitled to keep the deposit because they had not suffered any actual damages; therefore, it reasoned, liquidated damages would be a penalty, as opposed to compensation for a real loss.
On appeal to the Supreme Judicial Court of Massachusetts, that court observed that liquidated damages clauses, such as the one contained in the Agreement, are recognized in Massachusetts and are common practice in real estate transactions. The issue was whether the enforceability of a liquidated damages clause should be tested by analyzing the circumstances that existed at the time the contract was formed (called the “prospective” or “single look” approach), or at the time of the breach (the “retrospective” or “second look” approach.)
Quoting another Massachusetts case, the court explained that in general, “[w]here actual damages are difficult to ascertain and where the sum agreed upon by the parties at the time of the execution of the contract represents a reasonable estimate of the actual damages, such a contract will be enforced.” It also explained that liquidated damages will not be enforced if they are “grossly disproportionate to a reasonable estimate of actual damages.”
The Kelly court determined that, in Massachusetts, the “single look” approach should be used, and therefore, only the circumstances at the contract’s formation should be analyzed. It stated that, in the situation at hand, potential damages were difficult to predict at the time the parties entered into the Agreement. “The parties could not know what delays might ensue, what might occur in the real estate market, or how a failed sale might affect the seller’s plans. Real estate purchase and sale agreements are precisely the type of contracts that are amenable to liquidated damages provisions.”
The court affirmed the decision of the trial court, and the Sellers were permitted to keep the full amount of the Kellys’ deposit.
Note: Please be aware that while some states follow the “single look” approach in determining whether liquidated damages should be enforced, other states use the “second look” approach, and consider the circumstances at the time of the breach.
Kelly v. Marx, 428 Mass. 877, 705 N.E.2d 1114 (Mass. Ct. App. 1994)