BILL ANALYSIS
SENATE JUDICIARY COMMITTEE
Martha M. Escutia, Chair
2003-2004 Regular Session
AB 728 A
Assembly Member Leno B
As Amended July 22, 2003
Hearing Date: August 19, 2003 7
Business and Professions Code 2
CJW:cjt 8
SUBJECT
Real Estate: Condominiums: Financing
DESCRIPTION
This bill would make it easier for developers to finance
condominium projects by allowing them to (1) pre-sell
individual condominium units earlier in the development
process, and (2) retain enough of the buyer's deposit to
cover actual damages suffered when a buyer of a pre-sold
unit defaults on the contract. To accomplish the second of
these goals, the bill would establish an exception to the
existing "liquidated damages" statute for contracts for the
sale of residential property.
(This analysis reflects author's amendments to be offered
in Committee.)
BACKGROUND
According to a 2002 San Francisco Chamber of Commerce
report, existing laws governing residential construction
and financing can hamper developers trying to obtain
favorable financing for attached housing projects,
particularly condominiums. Builders and lenders say that
attached housing is financially riskier to develop than
standard subdivisions, because once the project is begun,
all of the units must be built, whereas subdivisions of
detached homes may be undertaken in phases or even one at a
time. The Chamber's report argued that statutory changes
that cut the risk of building attached housing could boost
(more)
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condo construction and increase homeownership.
AB 728 would make it easier for developers to obtain
financing for condominium projects by allowing them to
pre-sell more condominium units, and would create an
exception to the existing "liquidated damages" rule for
residential property sales to more effectively cover
developer's damages in the event of a buyer's default.
AB 728 already was heard by the Senate Local Government
Committee, which reviewed the provisions that would amend
the Subdivided Lands Act and the Subdivision Map Act (see
Comments 3 and 4 of this analysis). The bill has been
referred to this Committee for review of its proposed
exception to the liquidated damages statute, which is
analyzed in Comments 1 and 2.
CHANGES TO EXISTING LAW
1. Existing law provides that, in a contract for the sale
of residential property, a provision allowing the seller
to retain some or all of the buyer's deposit as
"liquidated damages" if the buyer defaults on the
contract must satisfy one of these conditions:
(a) If the amount paid does not exceed three percent of
the purchase price,
the provision is valid unless the buyer establishes
that the amount is
unreasonable as liquidated damages.
(b) If the amount paid exceeds three percent of the
purchase price, the
provision is invalid unless the seller establishes
that the amount is
reasonable as liquidated damages.
This bill would provide that, when a buyer has paid more
than three percent of the purchase price under a
liquidated damages clause in a contract to purchase a
newly constructed attached condominium unit, and later
defaults on the contract, the seller shall:
(a) account for its costs and revenues fairly allocable
to the construction and
sale of the unit, including costs related to the
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buyer's default, within 60
days of the unit's final sale;
(b) make reasonable efforts to mitigate any damages
arising from the default;
and
(c) refund to the buyer any amount in excess of either
three percent of the purchase price or the seller's
actual damages suffered as a result of the buyer's
default, whichever is greater.
This bill further would provide that, if the amount
retained by the seller after the accounting does not
exceed three percent of the purchase price, the amount is
valid unless the buyer establishes that the amount is
unreasonable.
This bill further would provide that if a "newly
qualified buyer" contracts to purchase the property in
question for the same price or a higher price than the
defaulting buyer had contracted to pay, the accounting of
any actual damages shall be performed within 60 days of
the execution of the new contract.
This bill further would define a "newly qualified buyer"
as one who (a) has contracted to pay a purchase price
equal to or greater than that contracted for by the
original buyer; and (b) has been issued a satisfactory
loan commitment, as defined.
2. Existing law , the Subdivided Lands Act, allows for the
sale of residential units in specified multiple-unit
developments prior to the completion of construction once
the Commissioner of Real Estate has issued a conditional
public report on the project. [Bus. & Profs. Code Sec.
11018.2.]
Existing law further provides that the term of a
conditional public report shall not exceed six months,
and may be renewed for one additional term of six months,
if the Commissioner determines that the requirements for
issuance of a public report are likely to be satisfied
during the renewal term.
This bill would provide that the term of a conditional
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public report for attached residential condominium units
consisting of 25 units or more shall not exceed 30
months, and may be renewed for one additional term of six
months if the Commissioner determines that the
requirements for issuance of a public report are likely
to be satisfied during the renewal term.
3. Existing law , the Subdivision Map Act, provides that a
map of specified multiple-unit dwellings need not show
the buildings or the manner in which they are configured,
and that the governing body may not refuse approval of a
parcel, tentative or final map of the project based on
the absence of this information. [Govt. Code Sec.
66427.]
This bill would provide that a map need not include a
condominium plan or plans, as defined, and that the
governing body may not refuse approval of a map on
account of the absence of a condominium plan.
This bill further would provide that, once a tentative
map is deemed approved, a subdivider shall be entitled,
upon request of the local agency or the legislative body,
to receive a written certification of approval.
COMMENT
1. Stated need for legislation to create exception to
liquidated damage law
According to the author, AB 728 would help condominium
development by making it easier for developers to obtain
larger buyer deposits on pre-sold condo units, and then
using those deposits to obtain bigger construction loans
at better terms.
Under existing law, a sales contract for residential
property may require the buyer to pay the seller
"liquidated damages" if the buyer fails to complete the
deal. Liquidated damages are a predetermined amount of
money damages, often paid as a pre-sale deposit on
residential property, that the seller may retain upon
breach of contract when the exact amount of actual
damages from the breach would be difficult to determine.
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Current law presumes that a provision for liquidated
damages in an amount up to three percent of the purchase
price of the property is valid, placing the burden on the
buyer to show that the amount is unreasonable. When a
contract provides for liquidated damages exceeding three
percent of the purchase price, the provision is presumed
invalid unless the seller shows that the amount is
reasonable.
Some builders say that California's three percent limit
on liquidated damages makes it more difficult to obtain
attractive financing terms for condominium projects.
Since the amount of a buyer's deposit that a seller may
retain if the buyer defaults is fairly low, sellers must
obtain more financing at less attractive terms than they
would if funds from pre-sold units were more reliable,
instead of being subject to refund upon buyer default.
Builders note that other states have either higher caps,
or no caps at all, on the amount of a deposit that may be
retained as liquidated damages when a buyer defaults on a
contract.
An earlier version of this bill would have done away with
any caps on liquidated damages clauses in contracts for
the purchase of newly constructed condominiums. In
response to arguments that this would unfairly shift the
risk of construction from developers and banks to home
purchasers, however, the bill has been amended to
establish a new process for determining damages when a
buyer defaults on a contract to purchase a newly
constructed condominium.
(a) Bill would allow seller to retain the greater of
three percent of the purchase price or the actual
damages from the buyer's default
Under the proposed process, when a buyer has deposited
over three percent of the purchase price under a
liquidated damages clause in a contract for a newly
constructed condominium, and later defaults on the
contract, the seller would have to provide an
accounting that indicates what actual damages were
suffered as a result of the buyer's breach. The seller
would then be obliged to refund to the buyer any amount
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of the deposit in excess of either three percent of the
purchase price of the unit or the seller's actual
damages, whichever is greater.
Thus, for example, a buyer of a proposed-to-be
constructed $400,000 condominium unit in San Francisco
might agree to pay eight percent of the purchase price
as a deposit, which would give the developer $32,000 in
up-front cash to assist in financing the overall
project. If the buyer defaulted on the contract prior
to the close of the sale, the developer would be
obliged to perform an accounting of its losses
resulting from the default.
If the damages were less than three percent of the
purchase price ($12,000), the developer would be
allowed to retain the entire $12,000 as "liquidated
damages," in accordance with existing law, unless the
buyer establishes that the amount is unreasonable. The
developer would then be required to refund $20,000 to
the buyer (the difference between the $32,000 deposit
and the $12,000 liquidated damages amount).
However, if the developer had to sell the unit for
$385,000 -- a $15,000 loss on the original purchase
price -- the developer would be entitled to retain
enough of the deposit to cover the damages, and the
refund to the defaulting buyer would be $32,000 minus
$15,000, or $17,000. (This is a very simple example;
an actual accounting of costs and revenues related to
the construction of the unit and taking into account
the buyer's default may be expected to be much more
complicated.)
(b) Seller would be required to mitigate damages
The seller also would be obliged to "mitigate damages"
- that is, to make reasonable efforts to limit the
damages caused by the default, which is standard
contract law. In this context, mitigation of damages
would include looking for a new buyer for the unit, or
allowing the defaulting buyer to do so.
To this end, the bill would allow the buyer or seller
to bring in a "newly qualified buyer" to take over the
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first buyer's contract at an equal or higher price,
which could diminish or eliminate any damages suffered
by the seller as a result of the first buyer's breach.
Mitigation of damages also would include promptly
returning the unit on which the default occurred to the
pool of unsold units still being offered for sale, so
it might be purchased as soon as possible, instead of
withholding it from the market until the other units
were sold.
2. Author's amendments will clarify "liquidated damages"
provisions
(a) To clarify the circumstances under which the bill's
accounting and refund process is meant to take place,
the author will amend the bill (at page 8, line 11) to
add the phrase "in the event of a buyer's default" at
the end of the sentence.
(b) To simplify the language describing the accounting
and refund process provided for by this bill, and to
provide that the seller is required to make reasonable
efforts to mitigate these damages in accordance with
existing law, the author will amend the bill as follows
(at page 8, lines 16-26):
(B) The accounting shall include any and all costs
and revenues related to the construction and sale of
the residential property and any delay caused by the
buyer's default. The seller shall make reasonable
efforts to mitigate any damages arising from the
default. In the event that the accounting
establishes that the seller did not incur damages in
excess of 3 percent of the purchase price in the
terminated transaction on the sale of the
residential property as a result of the buyer's
default, then the The seller shall refund to the
buyer any amounts previously retained as liquidated
damages in excess of the greater of either 3 percent
of the originally agreed upon purchase price of the
residential property or the amount of the seller's
losses resulting from the buyer's default, as
calculated by the accounting.
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(c) To allow a defaulting buyer to mitigate damages by
securing another buyer in the existing purchasing pool
to assume the terms of his or her contract (which would
make the other buyer liable for damages in accordance
with this bill for defaulting on that buyer's existing
contract), the author will delete the provision
prohibiting such a substitution (at page 9, lines
16-18).
3. AB 728 would extend the duration of conditional reports
The Subdivided Lands Act prohibits the sale of parcels
until the Real Estate Commissioner issues a final public
report ("white paper") that discloses key information to
prospective buyers. However, the Act allows sales of
units in condominiums and other multiple-unit
developments prior to the completion of the project if
the Commissioner issues a conditional report. A
conditional report is valid for six months, but may be
extended for another six months if the Commissioner
determines that the requirements for the white paper will
be met during the renewal period.
One requirement for a white paper is that the builder
record a final subdivision map issued under the
Subdivision Map Act. If the builder doesn't record the
final map in time, and the Commissioner doesn't issue the
white paper, the builder must return the buyers'
deposits.
Condominium builders say that one reason that
construction loans are expensive is because they can't
sign sales contracts for individual units until the
entire project is within six months or a year of
completion. Because building a multi-unit project and
getting a final subdivision map under the Map Act can
take several years, having a one-year conditional report
isn't enough time in which to sign up enough buyers to
obtain more favorable financing for the project.
AB 728 would provide that, for condominium projects
consisting of 25 units or more, the duration of a
subdivision conditional report would be extended from six
months (with one six-month extension) to thirty months
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Page 9
(with one additional six-month extension).
4. Bill also would clarify that subdivision maps must be
timely approved
Condominium projects are subdivisions under the
Subdivision Map Act, and their builders must obtain local
approval of tentative and final maps of the project.
Under state law, tentative maps must be approved within
specified time periods or they are "deemed approved." In
addition, prior to being issued a certificate of
occupancy for the completed building, builders must
obtain approval of a condominium plan, and comply with
other conditions imposed by state law or local ordinance.
In order to obtain the conditional report allowing them
to pre-sell units, however, condominium builders need to
have their maps approved. Some builders say that cities
and counties improperly impose conditions on map
approvals that are not authorized under the law, and that
are more appropriately dealt with as conditions for the
certificate of occupancy, in order to gain additional
time for map review and avoid the "deemed approval" of
maps not approved before the statutory deadlines. In the
same vein, builders say some local bodies will simply
refuse to record tentative maps that have been "deemed
approved" under existing law.
Existing law provides that map approval may not be
conditioned on the lack of a plan showing the buildings
or the manner in which they are to be divided into units.
To ensure that approval of building placement and
configuration will still occur at some point in the
process, existing law also provides that a legislative
body has the right to regulate the design or location of
the buildings pursuant to local ordinances.
AB 728 would prohibit a city or county from refusing
approval of a parcel map, tentative map, or final map for
a condominium project because of the absence of a
condominium plan showing the location or configuration of
the buildings. Further, the bill would provide that,
once a tentative map is "deemed approved" under the law,
the builder shall be entitled, upon the request of the
local agency or legislative body, to receive a written
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certificate of approval.
5. No opposition to bill
The California State Association of Counties and the
American Planning Association are neutral on AB 728. The
bill's recent amendments also have addressed concerns
raised by the California Realtor's Association. No
opposition to the bill has been received.
6. Additional author's amendments
(a) To clarify that purchase monies for pre-sold units
shall be held in escrow
in accordance with existing law, the author will amend
the bill (at page 6,
line 4) to add "subdivision (a) of" to its references
to Sections 11013.2 and
11013.4 of the Business and Professions Code.
(b) To correct an error in a previous amendment that was
intended to restore
an existing provision of law, the author will amend
the bill (at page 6, lines
33-34) to delete "additional terms of six months each"
and reinsert "one
additional term of six months."
(c) To limit the extension of the duration of
conditional reports to projects
large enough to merit the extension, the author will
amend the bill as follows (at page 6, line 37, to page
7, line 3):
(i) The term of a conditional public report for
attached residential condominium units consisting of
10 units or more , as defined pursuant to Section 783
of the Civil Code, consisting of 25 units or more as
specified on the approved Tentative Tract Map, shall
not exceed 30 months and may be renewed for one
additional term of six months if the commissioner
determines that the requirements for issuance of a
public report are likely to be satisfied during the
renewal term.
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Support: Bank of America; Bank One; California Building
Industry Association; Home Ownership Advancement
Foundation; KeyBank; San Francisco Chamber of
Commerce
Opposition: None Known
HISTORY
Source: Author
Related Pending Legislation: None Known
Prior Legislation: AB 2490 (Brulte), Ch. 860, Stats. of
1992 (authorized DRE to issue conditional
final reports for real estate development
projects)
Prior Vote: Assembly Committee on Local Government 8-0
Assembly Appropriations Committee 24-0
Assembly Floor 74-0
Senate Committee on Local Government 7-0
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