Buyer's deposit off-limits in failed sale

REThink Real Estate

By Inman News Feed
Add Comment Add Comment | Comments: 0 | Posted Sep. 2, 2010

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REThink Real Estate

Tara-Nicholle Nelson
Inman News

Q: The buyer of our home took us right up to one week before the closing date and backed out, stating he found another home he liked better. We had complied with all of his requests, including a quick closing date and home inspection, and he was preapproved for a loan. We purchased another home quickly due to his demands.

We even packed up our whole home and had done minor repairs he demanded be done. Now we are told we are not entitled to the earnest money. Why? --Jan, Utah

A: Well, Jan, you appear to have had your good faith taken advantage of by someone who knew your side was dozing a bit at the wheel. Clearly, I don't know all of the facts of your case, but there are some common misconceptions about deposit refunds and contingency periods that seem to have been present in your situation.

So, virtually every real estate contract in every state has some sort of due diligence time period in which the buyer is able to back out and recoup his deposit for a certain number of days following the execution of the contract. (The number of days varies widely, and is something that is negotiated between the buyer and seller.)

In some states, that time period is known as an objection period: the buyer has 20 days, for example, in which to object to the transaction for any number of reasons listed in the contract. Commonly specified grounds for backing out include the property's failure to appraise at the purchase price, or failure to pass muster after an inspection.

If the buyer does not object within that time period and does not obtain an extension of his objection period from the seller before it expires, his earnest money deposit automatically becomes nonrefundable if he fails to close the transaction for any reason.

In most states, though -- including California and Utah -- the time period for the buyer's due diligence is known as a contingency period. The contract sets forth a specific period of time -- often ranging from 10 to 20 days on today's market -- in which the buyer is supposed to obtain his inspections, finalize his financing, have the property appraised, and so forth.

At the end of that time period, the buyer agrees to either exercise his contingencies and back out of the transaction, or remove them and notify the seller that he intends to do the deal.

That is, in contingency states, the earnest money deposit is rendered nonrefundable only when the buyer actually signs and delivers to you or your agent his express removal of all contingencies.

This nonrefundability is generally contained in a specific liquidated damages clause that provides that both buyer and seller agree that if the buyer breaches the contract by backing out of the deal, the seller can keep the earnest money deposit up to 3 percent of the purchase price.

This specific clause must be initialed by both buyer and seller to apply, in addition to their signatures at the end of the contract.

Despite the fact that the buyer's contingency period might have expired, if either (a) he or you failed to initial the liquidated damages clause in the contract, or (b) he never signed and delivered a document removing all of his contingencies, you do not have the right to keep his earnest money deposit.

I'm assuming you had your own real estate broker or agent; if not, your situation is a crystal clear example of why it is advisable to have an experienced broker represent you even if you think you can get your home sold on your own.

As part of the initial contract negotiations, many agents would have advised you about the importance of including the liquidated damages clause in the contract.

And certainly, before you went out and bought another home, the average broker I know would have verified that the buyer's earnest money deposit check had cleared, and that he had expressly removed all his contingencies so that you would at least be able to retain the deposit if he backed out.

While it sounds extremely rude, selfish and ungrateful for the buyer to flat out tell you the reason he's backing out is that he found another home, the reality is that so long as his inspection contingency is still in effect, he could simply state another, more robust grounds for backing out if pressed, and be well within his rights under the contract.

Given the serious nature of the matter, I would encourage you to try to pinpoint exactly where things went wrong in more detail with your listing agent -- and his or her managing broker.

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