Housing Counsel: Who Gets the Earnest Money Deposit

Written by Posted On Sunday, 04 September 2005 17:00

Question: I signed a real estate contract in July and my real estate broker is holding the earnest money deposit in the amount of $25,000. The buyer had twenty days in which to get financing, but apparently was unable to get a loan commitment. I was not advised of this until last week -- which was well past the 20 day contingency. The contract requires that settlement take place on September 2, 2005. What should I do? Can I keep the deposit if settlement does not take place?

Answer: You must first carefully read the sales contract. You state that the buyer had 20 days in which to get financing, but what happens if no loan has been obtained within this period of time. Some sales contracts state that the buyer can terminate the contract and get the deposit back, if within the contingency period of time spelled out in the contract the buyer specifically advises the seller in writing that financing is not available. If, on the other hand, the buyer does not so advise the seller within the contingency period, the buyer loses this right and remains legally obligated to comply with the terms and conditions of the contract. Then, if the buyer does not go to closing, he would forfeit the deposit to the seller.

Other sales contract take a different approach. For example, the Regional Sales Contract used in the Washington metropolitan area permits the contingency to continue beyond the stated period of time.

However, the seller has the right to give the buyer written notice that the contract will become null and void within three days unless the buyer:

  1. delivers to Seller a lender's approval letter, or

  2. removes the financing contingency and provides the seller with evidence of sufficient funds available to complete settlement without obtaining financing

If the language in your sales contract permits you to void the contract, then your buyer is not in default and you may not be able to keep the earnest money deposit.

How do you determine if your buyer is in default? Once again, you have to look to the sales contract. Most contracts define "default." For example, in the Regional Sales contract, the buyer is in default if:

  1. he fails to promptly apply for financing if the contract is contingent on obtaining a mortgage loan

  2. he does not comply with a potential lender's reasonable requirements

  3. makes any "deliberate misrepresentations, material omissions or inaccuracies in financial information that result in the Purchaser's inability to secure the financing"

In your situation, you have two alternatives.

First, you can declare the contract null and void, in which case you will have to authorize the escrow agent to release the earnest money deposit back to the buyer.

Second, you can wait until September.

Third, you can show up at settlement ready, willing and prepared to convey title to the buyer. If the buyer does not show up -- or is unable to complete closing because he does not have enough money -- you can then declare him in default and attempt to get the earnest money from the escrow agent.

The earnest money deposit is held in escrow. What exactly does that mean? An online dictionary defines escrow as "a deed, a bond, money, or a piece of property held in trust by a third party to be turned over to the grantee only upon fulfillment of a condition."

The escrow agent, which is usually a real estate broker or the settlement attorney, is under a duty, imposed by law, not to deliver the deposit to anyone except upon strict compliance with the conditions spelled out in the sales contract.

Thus, even if you believe that your buyer is in default, the escrow agent should not release funds to you unless the buyer gives his consent. Most escrow agents have a form release, which is signed by buyer and seller (and any real estate agents involved), authorizing how the deposit is to be distributed. For example, in your case, your buyer may deny being in default. You will either have to try to reach a negotiated settlement with him or file suit. The escrow agent will not release the funds unless there is a written release or a court order spelling out how and where the deposit should be disbursed.

Litigation is time-consuming, expensive and uncertain. Our courts follow the American Rule on legal fees, namely, with few exceptions, each side pays his/her own attorney. The relevant exceptions include:

  • where a statute provides attorneys fees to the prevailing party, such as a consumer protection law;

  • where the contract specifically provides that the losing party in court will pay attorneys fees, or

  • where the court finds that one party has acted so egregiously that the court will award legal fees to punish that person. This is a rare occurrence in court cases.

If your house has increased in value, you would be well advised to terminate the contract, return the deposit to the buyer, and try to sell to another person, especially since the market is still active. On the other hand, if property values are slowing down, or you believe that it will be difficult to sell your house again, you will have to wait until the settlement date before your buyer can be considered in default.

There is a moral to this: do not rely exclusively on form contracts. They are basic, and in many cases must be tailored to meet the specific needs of the buyer and seller. In the future, I would add the following language as an addendum to the contract:

If the purchaser does not obtain a firm, binding loan commitment letter from a mortgage lender within ___ days, and does not advise seller of this fact within said period of time, the financing contingency will be deemed to have been removed and the purchaser will be obligated to go to settlement in accordance with the terms and conditions of this contract.
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Benny L Kass

Author of the weekly Housing Counsel column with The Washington Post for nearly 30 years, Benny Kass is the senior partner with the Washington, DC law firm of KASS LEGAL GROUP, PLLC and a specialist in such real estate legal areas as commercial and residential financing, closings, foreclosures and workouts.

Mr. Kass is a Charter Member of the College of Community Association Attorneys, and has written extensively about community association issues. In addition, he is a life member of the National Conference of Commissioners on Uniform State Laws. In this capacity, he has been involved in the development of almost all of the Commission’s real estate laws, including the Uniform Common Interest Ownership Act which has been adopted in many states.

kasslegalgroup.com

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