Earnest Money Battles

These options may help buyers and sellers avoid lawsuits over contract breaches.

September 18, 2013

Your client has put up $5,000 in earnest money and entered into a contract to buy a house, but despite her best efforts, she’s unable to secure financing. Citing this loan contingency, she exercises her right to terminate the contract and recoup her earnest money, but the escrow agent can’t release the funds because the seller—in clear violation of the terms of the agreement—refuses to acknowledge contract termination.

It would be nice to hope for a lightning bolt of common sense to strike someone whenever he or she so clearly breaches a contract, but the reality is that contracts don’t enforce themselves and filing a lawsuit is an expensive, stressful, and uncertain action to take.

In many situations like this, although contract termination is the sticking point, the main issue for buyers is simply getting their earnest money back. In light of this, here are a few things you can do to help make earnest money less of an issue whenever a seller refuses to acknowledge contract termination. None of these alternatives are ideal, but they at least give your buyer some options to consider other than suing.

Put up no earnest money. If your buyer puts up no earnest money, the buyer and seller can’t skirmish over it after contract termination. Contracts must be supported by consideration, but the exchange of the buyer’s promise to buy for the seller’s promise to sell is sufficient consideration to create a contract. For buyers who have no tolerance for earnest money fights, the only option is to have a contract without earnest money—-although there’s no guarantee the seller will agree to it.

Put up earnest money deposits in stages. This is slightly more attractive to a seller. The buyer could propose, for example, $1,000 of earnest money payable upon execution of the contract, with another $4,000 due after the buyer clears her due diligence contingencies.

‘Sue or shut up’ clause. The agreement between the seller and the buyer could remove the power of the seller’s refusal to authorize refund of the earnest money by requiring the escrow agent, or whoever is holding the funds, to refund the earnest money to the buyer unless the seller initiates a lawsuit to retrieve the earnest money by a clear deadline. It is easy for a lazy seller to decline to authorize the release of earnest money; 
it requires tenacity for the seller to file a suit to hold the money back. With a “sue or shut up” clause, the seller’s refusal to authorize earnest money release might only briefly tie up buyer funds.

‘Loser pays’ contract clause. Occasionally, a provision providing that the breaching party pays the nonbreaching party’s attorney’s fees can move the breaching party to honor the contract. Yet a “loser pays” clause like this doesn’t move the irrational or impoverished seller and sometimes emboldens a party who doesn’t understand the weakness of his position.

A different earnest money holder. The buyer might receive some comfort from having the earnest money held by someone aligned with the buyer. For example, the buyer’s agent, rather than the listing broker, can hold the earnest money.  A friendly earnest money holder decreases the chance of an inadvertent (or intentional) release of the earnest money to the wrong side.

Again, contracts do not enforce themselves. Sometimes parties who are clearly in the right find they have no choice but to file a lawsuit to enforce the terms of the contract. By sharing some of these other ideas with buyers, you might be able to take steps to reduce some of the risks and avoid full-blown legal fights over earnest money.

Jonathan A. Goodman is a shareholder in the law firm of Frascona Joiner Goodman & Greenstein, P.C., in Boulder, Colo. His practice areas include real estate, real estate finance, and broker representation. He can be reached at jon@frascona.com.