Yaniv and Michal purchased a beautiful apartment near Ra’anana for 2,000,000 NIS (about $550,000). Everything about the apartment was perfect for them except for one “small” complication—the apartment was encumbered by the seller to both a mortgage bank and to a third party. This was particularly problematic for Yaniv and Michal because they needed to mortgage the apartment in order to help finance the purchase and few banks would be willing to release money towards a property already encumbered. The seller agreed to pay off all outstanding debts from their initial purchase payments to ensure there would be no liens against the apartment, thus allowing Yaniv and Michal to get a mortgage for the next payments. The two sides entered into an agreement that set damages resulting from a breach of contract at $55,000 (10 percent of the purchase price).
The buyers made their first payments directly to the debtors (the bank holding the mortgage and the third party), to ensure these payments would satisfy the debts and remove the liens on the property. This would allow Yaniv and Michal to obtain a mortgage that would cover the remaining payments.
Immediately thereafter, their purchase ran into serious issues. After their first payment, Yaniv and Michal were surprised to see that a new lien had been set on the apartment due to an undisclosed additional debt the seller had accrued from unrelated business dealings. This meant that the seller had not arranged that all of the encumbrances were removed, as the agreement obligated him to do. Because of this new encumbrance, Yaniv and Michal could not mortgage the property to their bank, and therefore could not continue making payments on the property.
This brought their purchase process to a grinding halt.
In light of the new lien, it seemed like a hopeless situation, as seemingly they had no way to extract their capital, continue their payments and obtain ownership of their new apartment. After carefully weighing their options, the couple decided that their best option was nevertheless to forge ahead, and in alternative ways raise funds to complete the purchase, even without the possibility to mortgage the apartment that they had purchased.
Some of the desperate actions they undertook were as follows: They maximized short-term high-interest loans from their credit cards, took regular high-interest bank loans, arranged an early withdrawal of their pension plans for which they were charged penalties and taxes and pawned some of their silverware, jewelry and paintings.
After a few months and with great effort and incurring many expenses they were able to obtain enough money to remove the new lien on the property and pay off the seller. They accomplished the impossible, albeit at a great financial and personal expense.
Shortly after, Yaniv and Michal filed a lawsuit in the Magistrate’s Court against the seller claiming breach of contract for failing to rid the apartment of all its liens. They demanded the full amount of $55,000 in damages, as stipulated in the contract.
At this point we need to present a short description of how contract damages are dealt with in Israel. We will conclude our presentation by informing you how their lawsuit was resolved.
Boilerplate real estate purchasing agreements usually include a provision for damages resulting from a “fundamental breach of contract.” Such agreements usually also stipulate what constitutes a fundamental breach of contract and spell out each party’s primary obligations, such as the penalties for late payment or delayed settlement.
The agreement usually grants the offending party a grace period of several days to rectify the situation. Once the grace period has elapsed, the injured party can demand the offending party pay damages per their agreement.
Usually, contract damages are set at 10-15 percent of the purchase price, which is a substantial sum of money. Some agreements go even further, setting damages at 20-30 percent of the purchase price.
The purpose of damages is to compel both sides to comply with their contractual obligations, even if they must go to great lengths to do so. When such damages are hanging in the balance, both parties will do everything in their power to avoid breaking the contract.
An additional reason for specifying contract damages is to simplify the legal process. Rather than argue in court over the amount of damages owed by the offending party, both sides agree to a specified amount in advance. If the contract is broken, this amount is then specified in the lawsuit.
However, even though the amount of damages is specified in the agreement, the courts, based on Israeli law, have the authority to reduce (or increase) this amount. The logic behind this law is that, when two sides enter into an agreement, neither anticipates a breach of contract. They are optimistic that the damages provision will never be necessary.
But in reality often things do not happen as planned. This opens the door for court interference in setting the amount for damages. Considering that no reasonable person would sign an agreement thinking he would breach it, he would be inclined to agree to an especially high sum for damages. The law and legal precedent therefore call upon the courts to interfere and examine what damages would be reasonable on a case-by-case basis.
Moreover, the courts examine whether the injured party is being compensated unreasonably and/or disproportionately relative to the actual damage he or she has incurred. The purpose of damages is to compensate the injured party for expenses incurred as a result of the breach, and to rectify the ensuing damage, and no more. A large “payday” that far exceeds any real injury is completely at odds with the spirit of tort law.
In other words, contract damages have the advantage of motivating both sides to keep their parts of the agreement, while leaving the actual amount to the court’s discretion in the event of a dispute.
When courts rule in cases of contract damages, i.e., in cases where the injured party sues for the full amount stated in the agreement, the court examines the ratio of contract damages to the actual damage that was foreseeable when the agreement was signed. If the court concludes that the ratio is disproportionate, damages will be reduced to match the amount of actual damage.
The courts, however, tend to interfere only in extreme circumstances, where the ratio of contract damages to actual damages is noticeably disproportionate. Moreover, they are not authorized to deny damages altogether, only to reduce (or increase) the amount of damages.
The possibility of reduced damages naturally encourages the offending party to prefer waiting for a court ruling before paying out damages. This often creates delays in payment of damages and results in court cases to determine the amount of compensation.
In light of the above, it is advisable that both parties agree on a reasonable and appropriate amount of damages when drafting the purchase agreement, rather than aiming for an extreme amount that may compel the courts to interfere in cases involving a breach of contract.
So what happened to Yaniv and Michal and how was their lawsuit resolved? In light of the difficult and challenging situation they had been forced into and in view of the extreme steps that they undertook to extricate themselves from their damaging and injurious position that was no fault of theirs, the court ruled in their favor and awarded them the full $55,000 amount of damages as specified in the agreement. In addition, they were awarded linkage differentials and interest, as required by law. With this ruling, the court showed it agreed that the actual damages incurred by the buyers approximated the damages set in the contract. The court further ruled that the seller must pay Yaniv and Michal’s legal fees in excess of NIS 25,000 that included their lawyer’s fees and filing fees and interest, as required by law.
Disclaimer: The information contained herein does not constitute legal advice and should not be relied upon in lieu of legal counsel.
If you enjoyed this article, we recommend you check out the rest of the articles in this series: “Everything You Need to Know about Israeli Real Estate”
(www.epsteinlaw.co.il).
By Yaacov Epstein
