What Are Liquidated Damages in a Builder Contract?

Liquidated damages are a pre-agreed amount that one party pays the other if they break the contract. In builder contracts, your earnest money deposit is usually designated as liquidated damages if you fail to close.

The Short Answer

A liquidated damages clause establishes a fixed amount of money that one party will pay the other as compensation if the contract is breached. Rather than going to court to determine damages, both parties agree in advance what the penalty will be.

In new construction, the most common form of liquidated damages is the forfeiture of your earnest money deposit if you fail to close on the home.

How It Works in Builder Contracts

Your purchase agreement likely states that if you default (fail to close for any reason not excused by the contract), the builder may retain your earnest money deposit as "liquidated damages."

In some contracts, the liquidated damages clause limits the builder's remedy to the deposit amount — meaning they cannot sue you for additional money. In others, the builder reserves the right to pursue further damages beyond the deposit.

When Liquidated Damages May Be Unenforceable

Courts will generally enforce a liquidated damages clause if the amount was a reasonable estimate of the builder's potential loss at the time the contract was signed.

If the liquidated damages amount is grossly disproportionate to the builder's actual damages, a court may find the clause unenforceable as a "penalty." For example, if a builder's actual damages from a cancelled deal are $2,000 but the deposit is $25,000, a court might question whether the clause is enforceable.

The standard varies by state. Some states are more protective of consumers than others.

What to Watch For

Check whether the contract designates the deposit as liquidated damages or as a penalty.

Determine whether the builder can pursue additional damages beyond the deposit.

Consider whether the deposit amount is proportional to the home's price and the builder's likely actual damages.

Ask your attorney whether the liquidated damages provision is enforceable in your state.

Related Content

Have a new construction contract? Scan it for $49 at fineprint.homes