Oregon 30-Hour Real Estate Law Practice Test

Kenneth kept Valerie's $5,000 earnest deposit after she backed out of their sale agreement. What legal concept does this illustrate?

1. Accepting liquidated damages

2. Rescission of contract

3. Mutual agreement

4. Breach of contract

The correct answer is: Accepting liquidated damages

The situation described illustrates the concept of accepting liquidated damages. In real estate transactions, an earnest money deposit serves as a demonstration of a buyer's serious intent to purchase a property. If the buyer backs out of the agreement without a valid legal reason, the seller may be entitled to keep the earnest money as compensation for the breach. Liquidated damages are predetermined amounts agreed upon in a contract to be paid if one party fails to fulfill their obligations. In this case, since Kenneth retained Valerie's deposit after she backed out, it indicates that he is interpreting her withdrawal as a breach of the contract, thus allowing him to accept the earnest deposit as liquidated damages. This approach is often stipulated in real estate contracts as a way to manage the consequences of one party not honoring the agreement, balancing both parties’ interests in the transaction. Rescission of a contract would imply that the contract has been canceled and restored to the parties involved as if it never existed, which doesn't apply here since Kenneth kept the deposit. Mutual agreement would suggest that both parties came to a consensus to cancel the agreement, which is also not supported by the facts since one party unilaterally backed out. Breach of contract is relevant but more specifically describes the nature of Valerie's