Navigating Earnest Money Disputes

There is nothing we enjoy more than helping our customers successfully close their real estate transactions. However, not all contracts result in closings, and occasionally disputes arise between Buyer and Seller concerning the return of earnest money.

The Basics

Why do we have earnest money? The short answer is that it is because it is called for in the Contract to Buy and Sell Real Estate. But historically, the purpose of earnest money is to represent a buyer’s good faith in entering into a real estate contract. When the parties enter into a real estate contract, the seller takes the property off the market while the parties perform the required due diligence to consummate the sale. If the buyer terminates the contract for a reason that isn’t contemplated in the Contract to Buy and Sell Real Estate, the buyer forfeits the earnest money to the seller. If the contract closes, then the earnest money is attributed to the buyer’s purchase price. When Buyer and Seller enter into a Contract to Buy and Sell Real Estate, the buyer agrees to pay a defined amount of earnest money, which will be held by an independent third party (most often the title company), for the benefit of both seller and buyer, and pursuant to the terms of the Contract.

Termination by Buyer

There are many circumstances described in the contract that allow a buyer to terminate the contract without forfeiting the earnest money. In most of these circumstances, the buyers must provide notice of the termination on or before a pre-determined date. If the buyer terminates timely and in accordance with one of the allowable circumstances defined in the contract, the earnest money holder may return the funds to the buyer. If the buyer terminates, but the termination is not in compliance with the terms of the contract, the earnest money may be disbursed to the seller. Upon termination of the contract, the earnest money holder may request mutual written instructions from the buyer and seller before disbursing the funds; alternatively, the earnest money holder may disburse the funds to one party or the other in accordance with the terms of the contract, absent an earnest money dispute.

The Earnest Money Dispute

Occasionally, when a contract terminates the buyer and seller don’t agree about who is entitled to the earnest money. If the earnest money holder determines, in its sole discretion, that an earnest money dispute exists, the contract allows the earnest money holder to do only one of three things:

• Hold the money and wait for resolution of any court action between Buyer and Seller; or
• Initiate a court action and deposit the funds with a court of competent jurisdiction; or
• Provide notice to Buyer and Seller that unless Land Title receives a copy of the summons and complaint between Buyer and Seller containing the case number of the lawsuit within 120 days of the notice, Land Title is authorized to return the earnest money to Buyer.

Resolving the Dispute

The parties must work out their dispute; because the earnest money holder holds the earnest money for the benefit of both parties, it cannot assist in resolving the dispute, even if it seems clear that one party is in the right and the other party is in the wrong. The contract requires the parties to mediate any dispute that arises relating to the contract, and this mediation could be a great first step toward resolving an earnest money dispute. That being said, the earnest money for residential transactions is often relatively low, and therefore, mediation might not make sense financially. If that is the case, then reaching out to the other party and trying to reach a resolution that both parties are comfortable with may be the best option.

The Seller must Act

Please keep in mind that once there is an earnest money dispute, there are no circumstances in which the funds will be automatically returned to the seller (even if the buyer is clearly not entitled to the funds). If you represent the seller and believe that your client is entitled to the earnest money, you must get the buyer to agree either informally or through mediation. The next option would be to obtain a court order directing the earnest money holder to return the funds to the seller. If you sit back and wait, the funds will either remain with the escrow holder, will be interpled to the court, or will be returned to the buyer automatically 120 days after the earnest money holder provides notice of the same. If the seller is entitled to the funds, but the buyer disagrees, the seller must take action.

If you need assistance in determining how to proceed when you have an earnest money dispute, you may consider reaching out to a licensed real estate attorney. Although Land Title is always eager to provide assistance to its customers, once an earnest money dispute exits, our ability to help is limited. Please reach out to your local Land Title representative with any questions you may have before you are in an earnest money dispute!