Why Do Lawyers Draft That Way? The Earnest Money Liquidated Damages Clause

Why do lawyers draft that way? Sometimes habit. Sometimes market. Rarely because anyone checked the case law.

What the Clause Is Supposed to Do

When a buyer and seller sign a purchase and sale agreement in a real estate transaction, they are not just agreeing on a price. They are allocating risk. One of the most fundamental allocations answers a simple question: If the buyer defaults, what does the seller get?

The earnest money deposit is the traditional answer. The buyer places funds in escrow at signing as a demonstration of commitment. If the transaction closes, the deposit applies toward the purchase price. If the buyer defaults, the seller keeps it.

When drafted as a liquidated damages provision, the clause does something more specific. It represents the parties’ pre-agreed answer to a difficult question: What did the seller actually lose when the buyer walked away?

A failed transaction can create real economic harm. The seller may face a lower resale price, carrying costs during a re-marketing period, lost opportunities for other transactions, or expenses incurred in reliance on closing. Those losses may ultimately be provable in litigation, but at the time the contract is signed they are uncertain and difficult to estimate with precision.

Liquidated damages solve that problem. Instead of litigating actual losses later, the parties agree in advance on a fixed amount that will substitute for those damages if the buyer breaches.

The seller gains certainty — no need to prove damages. The buyer gains a defined downside — the deposit becomes the price of walking away. Both sides trade the uncertainty of litigation for the efficiency of a predetermined result.

The arrangement works cleanly until the seller’s attorney decides the deposit may not be enough.

The Temptation: Preserving Both Remedies

Consider the numbers.

A buyer agrees to purchase a $10 million property and deposits $250,000 in earnest money. The buyer later defaults. Under a liquidated damages clause, the seller keeps the $250,000 and the deal is over.

But what if the seller ultimately resells the property for $1 million less?

Faced with that possibility, a seller’s attorney may attempt to preserve flexibility by adding language such as:

Seller’s retention of the earnest money shall not constitute a waiver of any other rights or remedies available at law or in equity.

Or:

Seller may retain the earnest money deposit and pursue any other remedies available at law or in equity.

This language feels protective, but, in many jurisdictions, rather than strengthening the clause it voids it.

The Split of Authority

Courts across the country have reached different conclusions about whether a seller may retain a deposit as liquidated damages while preserving the option to pursue actual damages.

The disagreement turns on how courts understand the nature of liquidated damages.

Some jurisdictions take a permissive approach grounded in freedom of contract. If sophisticated parties agree that the non-breaching party may elect between liquidated damages and actual damages, courts will generally enforce that arrangement so long as the remedies remain mutually exclusive once the election is made. The Colorado Supreme Court adopted this approach in Ravenstar, LLC v. One Ski Hill Place, LLC.

Other jurisdictions take the opposite view. Courts applying this reasoning conclude that preserving the right to pursue additional damages undermines the premise that the liquidated amount represents the parties’ agreed estimate of loss. The Indiana Court of Appeals applied that reasoning in Rogers v. Lockard, invalidating a clause that allowed the seller to retain the earnest money while also pursuing other remedies.

Additional doctrines can complicate the analysis. Some courts treat retention of the deposit itself as an election of remedies, foreclosing later damages claims, as the New Hampshire Supreme Court held in Orr v. Goodwin. Other jurisdictions impose procedural requirements before a seller may pursue actual damages.

The result is a genuine split of authority. Language that creates a valid election of remedies in one jurisdiction may invalidate the liquidated damages clause entirely in another.

For attorneys drafting purchase agreements, that difference matters.

The Illinois Rule

Illinois follows the restrictive approach.

For transactions governed by Illinois law, a liquidated damages clause that preserves the seller’s option to pursue actual damages is unenforceable.

The leading case is Grossinger Motorcorp, Inc. v. American National Bank & Trust Co. There, a purchase agreement allowed the seller to retain the earnest money as liquidated damages or pursue actual damages instead. The Illinois Appellate Court held the provision invalid because a clause that allows the seller to pursue additional monetary damages does not represent a genuine pre-estimate of loss. Instead, it functions as a minimum recovery and is treated as a penalty, which is unenforceable under Illinois law.

Importantly, the court distinguished between monetary remedies and equitable remedies. Preserving the seller’s right to pursue equitable relief, such as specific performance, does not invalidate a liquidated damages clause. The problem arises when the contract preserves the seller’s ability to recover additional money damages beyond the agreed liquidated amount. This distinction is consistent with the Illinois Supreme Court’s holding in Bauer v. Sawyer, where the court held that “even if the provision in question is construed as one for liquidated damages the right to an injunction is not barred.”

The court reinforced this principle in Catholic Charities of the Archdiocese of Chicago v. Thorpe, holding that even describing liquidated damages as something the seller may elect can imply the availability of actual damages and render the provision unenforceable.

The practical consequences of this rule can be significant. In Grossinger, once the liquidated damages clause was voided, the seller was limited to proving actual damages. The seller later resold the property for more than the original contract price and therefore suffered no damages. The buyer ultimately received a full return of its deposit despite breaching the contract.

The Separate Breach Exception

There is one narrow scenario where a seller may recover both liquidated damages and actual damages.

If the buyer commits a separate contractual breach unrelated to the failure to close, the seller may pursue damages for that breach without invalidating the liquidated damages provision.

The key is that the remedies address different injuries. The liquidated damages clause applies to the failure to close. The additional damages arise from a distinct contractual obligation.

Courts in other jurisdictions have recognized this principle where, for example, a buyer agreed to reimburse construction costs or perform other obligations independent of closing. Because the breaches were separate, recovery of both remedies was permitted.

For Illinois practitioners, the implication is largely a drafting one. If the parties intend the liquidated damages clause to address only the buyer’s failure to close, the agreement should state that clearly and treat other obligations separately.

A Final Thought

The earnest money liquidated damages clause appears in almost every purchase agreement, yet it is often copied from prior deals without careful attention to the governing law. Three lessons follow.

• First, know your jurisdiction. Language that creates a valid election of remedies in one jurisdiction may invalidate the clause entirely in another.
• Second, decide what remedy the clause provides. If the deposit is intended as liquidated damages for the buyer’s failure to close, the agreement should treat it as the seller’s agreed remedy and avoid language preserving additional monetary damages.
• Third, address other obligations separately. Breaches of other contractual commitments should have their own remedies rather than being folded into a single liquidated damages clause.

Every provision in a well-drafted agreement should exist for a reason grounded in both the parties’ objectives and the governing law. The earnest money liquidated damages clause is designed to provide certainty and efficiency. When drafted reflexively, it can produce the opposite result. The attorney who attempts to preserve every possible remedy may ultimately preserve none.

Questions about how to approach the liquidated damages provision in an upcoming transaction? Reach out to Benjamin Altshul, Natalie Boyd, or another member of LP’s Real Estate Group.