In most real estate transactions, accepted offers become completed sales and the buyer's earnest money becomes part of the purchase price. However, when real estate transactions fall apart, earnest money is refunded to the buyer more often than not. Let's take a closer look.
When Deals go Bad
The typical reasons for a broken deal are:
- Buyer dissatisfaction with property reports
- Buyer's inability to obtain financing
Both of these circumstances are typical “contingencies” in the California residential purchase agreement or other agreement.
Contrary to popular belief, earnest money is not automatically forfeited to the seller if the deal falls through. In fact, the purchase agreement in most states, including the California real estate purchase agreement, specifically states that the buyer is allowed to cite the contingencies listed above and cancel escrow without losing the earnest money. In California, only after the buyer submits a contingency removal form, which explicitly removes those contingencies, does the seller have a decent chance at claiming the earnest money. In Florida, it is more seller favorable, whereby the passage of contingency dates put the earnest funds at risk.
Contrary to popular belief, earnest money is not automatically forfeited to the seller if the deal falls through.
But What if the Buyer Causes a Deal to Go Bad?
Even if a buyer is responsible for a deal collapsing, the seller still often has a difficult time staking claim to the earnest money. This fact sounds unfair to sellers, and morally it is. Unfortunately, such unfairness is simply the reality, and here's why.
Earnest money is held in trust by an escrow company. Both buyer and seller must agree in writing on the release of the funds to the seller. Without a written agreement, escrow companies typically will not release the funds to the seller unless a court or arbitrator orders them to do so. It specifically so states in your purchase agreement and escrow instructions.
Usually, buyers won't sign a form that says they are willing to forfeit thousands of dollars. Furthermore, sellers are usually reluctant to take buyers to court, particularly because litigation can prevent the seller from entering escrow with another buyer. The reason this happens is because the seller's property is technically still in escrow with the original buyer. It will remain in escrow until the original buyer and seller sign escrow cancellation instructions.
Advice to Sellers
If the deal goes wrong, it is typically best for you as the seller to quickly sign the documents provided by the escrow company that refund the earnest money to the buyer. While litigation can be tempting, sellers are almost always best served by moving on to find the next buyer as quickly as possible.
If contingency removal has occurred and the buyer is unable to close, consider insisting on retaining the earnest money after serving your notice to perform. Understand, however, that in making such a decision, you may have to obtain a court order to get the funds from escrow, and you may delay your sale to a new buyer for six months or more until the litigation is settled.
If you have additional questions on earnest money refunds, ask us. If you need assistance drafting a notice to perform or escrow cancellation instructions, our transaction coordinators are here to help you.