This post first appeared in the Chicago Daily Law Bulletin in September, 2022.
Earnest money, as we all know, is the consideration given by the Buyer to bind the purchase contract. It is often the subject of liquidated damages in the Attorney Review letter where parties seek to have the earnest money be the sole remedy in the event of default, or to increase the earnest money to satisfy the Seller that the funds are sufficient to cover the carrying costs. The amount of earnest money provided by the Buyer is often how the Seller will judge the strength of an offer, since more money put at risk indicates a Buyer’s greater willingness and ability to proceed with the sale.
It is rare that I see a dispute regarding earnest money; generally, deals fall through over inspection issues, inability to agree to items of attorney review, or the failure to obtain financing. Those issues are all time-sensitive, and buyer’s counsel should – and generally do – advise terminating the contract before those deadlines expire.
But what if the attorneys don’t terminate the contract before the deadlines expire? I have a client who had two failed contracts on the same apartment. The first failure was due to the Buyer not obtaining financing. The Buyer’s attorney had not extended the mortgage contingency deadline. So while the Buyer attempted to terminate the contract and get my client, the Seller, to return the earnest money, the contract was actually in default.
The second failure was occurred because my client moved out prior to the scheduled closing and was not aware of mold that developed in the bathroom. The Buyer saw the mold during the final walk-through. The day of the final walk-through was blistering hot and the elevators in the high rise experienced a ten-minute failure. Because of these two issues, the Buyer chose to walk away from the transaction. Since all contingencies were expired, the Buyer was in default.
In both instances, due to the default, the Seller could have sued for damages. If the deals were cash transactions, the suit could have been for specific performance to force the Seller to close. Otherwise, damages could include any costs incurred up to the proposed closing date along with any carrying costs after the default – for instance association dues, real estate taxes, or interest on the mortgage. However, the cost of pursuing a buyer can be prohibitive.
So, the end result is that these matters tend to settle. For the Seller, it is better to settle because they cannot get the earnest money unless there is agreement on both sides. It is also better to settle so the property can be put back on the market – unless the intent is to sue for specific performance. The title company, after all, is going to require proof of the termination of a prior contract to clear the title report for a new contract. For the Buyer, it is better to settle too, and the Buyer may need to release some of the earnest money, because otherwise the Seller could sue. Like a renter’s security deposit, the earnest money can act as a security for the transaction, to be forfeited if the transaction falls through as “consolation” for the Seller.
While it is rare to see disputes over earnest money, it is not unheard of. And in a market unlike any we have seen before, prudent real estate lawyers will always keep issues regarding earnest money at the forefront of their minds while a transaction is pending.