Introduction to Earnest Money Law
Earnest money deposits are involved in almost every real estate transaction. Although not essential to the
creation of a valid and binding purchase agreement, it is the rare residential real estate transaction that does not require the Buyer to make an earnest money deposit. The earnest money is almost always turned over to the real estate broker who holds the money in trust for the parties to the transaction.
It is important that both the Buyer and Seller understand what the broker's legal obligations are with respect to an earnest money deposit. Therefore, there should be some discussion of these legal obligations in the purchase agreement that the parties execute.
creation of a valid and binding purchase agreement, it is the rare residential real estate transaction that does not require the Buyer to make an earnest money deposit. The earnest money is almost always turned over to the real estate broker who holds the money in trust for the parties to the transaction.
It is important that both the Buyer and Seller understand what the broker's legal obligations are with respect to an earnest money deposit. Therefore, there should be some discussion of these legal obligations in the purchase agreement that the parties execute.
The Law of Earnest Money
While the terms of the earnest money deposit should be defined in the purchase agreement, generally the deposit is delivered to the real estate broker at the time the offer is made, and the broker deposits the earnest money in his trust account either upon receipt or upon acceptance of the offer by the Seller, depending upon the terms of the purchase agreement. When the real estate transaction is closed, the earnest money is either returned to the
Buyer or the Buyer is given a credit against the purchase price.
There is almost never a problem with an earnest money deposit when the real estate transaction actually closes.
However, problems do arise when the real estate transaction fails, for whatever reason, and there is no closing.
This situation invokes not only the general law with respect to earnest money but should also cause the broker to examine his obligations with respect to the licensing laws.The general rule with respect to earnest money deposits is that the Buyer is entitled to a return of the deposit if the contract is not closed through no fault of the Buyer. Conversely, the Seller is entitled to the earnest money deposit if the Buyer breaches the purchase agreement.
The purchase agreement should specify that the retention of the earnest money by the Seller should not be the Seller's exclusive remedy, but he should also be permitted to pursue an action for specific performance or damages.
Most purchase contracts contain contingencies (most commonly relating to financing and inspection), which excuse the parties from performance if the contingencies are not satisfied or removed. If the contingencies are not satisfied, notwithstanding good faith efforts by the parties, then the contract is null and void, and the Buyer is entitled to a return of the earnest money deposit. However, if the Buyer does not act in good faith in attempting to satisfy the contingency, then a court may rule that the Seller is entitled to the earnest money even though the contingency has not been satisfied or removed.
When a real estate transaction fails, the broker who is holding the earnest money deposit in his trust account is placed in the position of having to decide which party is entitled to the earnest money. This is a position in which a broker should never place himself because the decision as to the proper recipient of the earnest money is a legal decision which should be made by a lawyer or the courts. The difficulty of this decision is compounded by the fact that, in most cases, the broker owes fiduciary duties to the Seller, and naturally those duties include obeying the lawful instructions of the Seller. In this situation, the broker's duties to the Seller would compete with the broker's duty to determine which party,if any, breached the purchase agreement, if he were to attempt to dispose of the earnest money on his own.
To avoid placing the broker in this difficult position, most often Real Estate Commission and the Division of RealEstate specify that a broker shall not disburse earnest money to any party unless the other party to the transaction has provided him with a release or authorization to do so.
If the parties refuse to give the broker appropriate authorization to disburse the funds, then the broker is required to keep the funds in his trust account until the parties provide him with an appropriate authorization or until a court of law orders him to disburse the funds.
Buyer or the Buyer is given a credit against the purchase price.
There is almost never a problem with an earnest money deposit when the real estate transaction actually closes.
However, problems do arise when the real estate transaction fails, for whatever reason, and there is no closing.
This situation invokes not only the general law with respect to earnest money but should also cause the broker to examine his obligations with respect to the licensing laws.The general rule with respect to earnest money deposits is that the Buyer is entitled to a return of the deposit if the contract is not closed through no fault of the Buyer. Conversely, the Seller is entitled to the earnest money deposit if the Buyer breaches the purchase agreement.
The purchase agreement should specify that the retention of the earnest money by the Seller should not be the Seller's exclusive remedy, but he should also be permitted to pursue an action for specific performance or damages.
Most purchase contracts contain contingencies (most commonly relating to financing and inspection), which excuse the parties from performance if the contingencies are not satisfied or removed. If the contingencies are not satisfied, notwithstanding good faith efforts by the parties, then the contract is null and void, and the Buyer is entitled to a return of the earnest money deposit. However, if the Buyer does not act in good faith in attempting to satisfy the contingency, then a court may rule that the Seller is entitled to the earnest money even though the contingency has not been satisfied or removed.
When a real estate transaction fails, the broker who is holding the earnest money deposit in his trust account is placed in the position of having to decide which party is entitled to the earnest money. This is a position in which a broker should never place himself because the decision as to the proper recipient of the earnest money is a legal decision which should be made by a lawyer or the courts. The difficulty of this decision is compounded by the fact that, in most cases, the broker owes fiduciary duties to the Seller, and naturally those duties include obeying the lawful instructions of the Seller. In this situation, the broker's duties to the Seller would compete with the broker's duty to determine which party,if any, breached the purchase agreement, if he were to attempt to dispose of the earnest money on his own.
To avoid placing the broker in this difficult position, most often Real Estate Commission and the Division of RealEstate specify that a broker shall not disburse earnest money to any party unless the other party to the transaction has provided him with a release or authorization to do so.
If the parties refuse to give the broker appropriate authorization to disburse the funds, then the broker is required to keep the funds in his trust account until the parties provide him with an appropriate authorization or until a court of law orders him to disburse the funds.
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In those situations where both the Buyer and the Seller claim a right to the earnest money deposit, and neither will authorize the broker to distribute the earnest money to the other, then the broker has two possible courses of action.
First, he should advise the parties that he is unable to release the earnest money deposit to either party without a court order or their agreement. He may then choose to leave the earnest money in his trust account and advise the Buyer and Seller that they must bring a court action and obtain a court determination as to who is the proper recipient of the earnest money deposit.
If either the Buyer or Seller commences an action, it is likely that the real estate agent will be included as a party defendant in the case, and the broker should merely advise the court that he will pay the earnest money deposit to whichever party the court specifies. Until a court order is obtained, the money must remain in the broker's trust account.
Alternatively, the broker may commence a legal action himself. He would be the plaintiff in the case and would name as defendants both the Buyer and the Seller. In his complaint he would ask the court to determine whether the earnest money deposit should be paid to either the Buyer or the Seller.
In this kind of "interpleader" action, the broker would be the "stake holder," and the Buyer and Seller would be required to set up their claims to the funds and convince the court that one or the other is entitled to the money.
Procedurally, it would probably be easiest for the broker to wait for the Buyer and Seller to commence an action, rather than commencing the action himself. Nevertheless, there may be situations in which the broker may want to commence the action himself so as to clear his trust account of the earnest money deposit.
First, he should advise the parties that he is unable to release the earnest money deposit to either party without a court order or their agreement. He may then choose to leave the earnest money in his trust account and advise the Buyer and Seller that they must bring a court action and obtain a court determination as to who is the proper recipient of the earnest money deposit.
If either the Buyer or Seller commences an action, it is likely that the real estate agent will be included as a party defendant in the case, and the broker should merely advise the court that he will pay the earnest money deposit to whichever party the court specifies. Until a court order is obtained, the money must remain in the broker's trust account.
Alternatively, the broker may commence a legal action himself. He would be the plaintiff in the case and would name as defendants both the Buyer and the Seller. In his complaint he would ask the court to determine whether the earnest money deposit should be paid to either the Buyer or the Seller.
In this kind of "interpleader" action, the broker would be the "stake holder," and the Buyer and Seller would be required to set up their claims to the funds and convince the court that one or the other is entitled to the money.
Procedurally, it would probably be easiest for the broker to wait for the Buyer and Seller to commence an action, rather than commencing the action himself. Nevertheless, there may be situations in which the broker may want to commence the action himself so as to clear his trust account of the earnest money deposit.
Earnest Money Law - Conclusion
In summary, when both the Buyer and Seller claim a right to the earnest money deposit, the broker must keep the earnest money in his trust account until the parties reach an agreement or a court issues an order. Many times when parties are initially unable to agree, a compromise can be struck when a broker advises the parties of his legal obligations with respect to the deposit. It is not necessary that the entire deposit be paid to either the Buyer or the Seller. To avoid a court action, the Buyer and Seller may wish to agree that one-half of the deposit should go to the Seller and one-half should go to the Buyer, or any other form of compromise. The broker would be authorized to distribute the earnest money in accordance with any compromise reached by the Buyer and the Seller, but he should be certain to receive a written authorization which describes the specific terms of the compromise.
More on Earnest Money
Here are the links to some pages with respect to other important earnest money questions:
Earnest Money Deposit
Earnest Money Agreement
Earnest Money Dispute
Earnest Money Deposit
Earnest Money Agreement
Earnest Money Dispute
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