In the rare event that a buyer backs out at the closing stage of a real estate transaction, significant issues arise, particularly concerning the earnest money deposit. The fate of this deposit typically becomes a central matter of negotiation between attorneys representing both parties.
Negotiating a Split
When a buyer backs out, attorneys often negotiate a split of the earnest money.
Complete forfeiture of the earnest money is rare because the cost and effort required to claim it often outweigh the benefit, especially for smaller amounts. Both parties must agree to the release of these funds from escrow.
If there is no mutual agreement, the money remains in escrow, potentially being transferred to the state after a period of time. There is a proposal to change the manner in which escrowees are required to deal with the release of earnest money currently being examined by the Illinois Mutli-board 8.0 Drafting Committee, of which I am a member.
Example of Earnest Money Dispute
Consider a commercial deal where a buyer put up $50,000 in earnest money but backed out without justification at the last minute.
The seller refused to sign off on the release of the earnest money. As a result, the money stayed in escrow. Without a backdoor agreement, this money would sit indefinitely or eventually go to the state.
Seller’s Carrying Costs
When a buyer backs out, the seller incurs real costs during the contract period, such as real estate taxes, utilities, and homeowner association dues. To address these costs, attorneys often negotiate a split of the earnest money based on the seller’s carrying costs and the current market conditions.
Market Conditions and Settlement
The likelihood of quickly finding another buyer influences the earnest money split.
In a hot market, sellers might swiftly secure a new buyer, whereas in a slower market, it might take longer, increasing the seller’s expenses. Typically, parties settle on an amount reflecting these considerations.
Limiting Damages in Contracts
Contracts often stipulate that the earnest money is the sole remedy for the buyer’s default.
A buyer may have a change in employment, losing a job right before closing causing their loan to be denied. This can be catastrophic for both the buyer and the seller. The buyer may lose their earnest money, because they had gotten a “clear to close” based on the expectation of employment and did not extend the mortgage contingency to the closing date. It can harm a seller who must now put their sale on hold and most likely a subsequent transaction.
So, if a buyer puts up $10,000, that is not necessarily their sole risk. If that is the agreement in attorney review, that is one thing. But without that agreement they may be looking at any costs the seller incurred based on the breach of contract. And the contract provides for attorneys’ fees in the event that the Seller is successful in prosecuting their claim. If the matter is to be settled, both parties must agree to release the funds.
Another possible issue might be a problem that becomes apparent on the final walk-through in an “as is” transaction that occurred after the contract had been finalized. In that instance, the buyer might be able to legitimately walk away or a hold-back and compensation might need to be negotiated for the damage that occurred.
The Importance of Detailed Agreements
Everyone would hope that incorporating clear terms regarding earnest money in the purchase agreement can prevent disputes and provide a smoother resolution if the buyer defaults. Sellers should be aware of their carrying costs and ensure these are considered in the event of a dispute.
A seasoned attorney may suggest solutions for these situations. Exquisite negotiations to keep the second deal together for the seller whose buyer lost their job might be necessary. A holdback for repairs might be necessary for the “as is” seller with an accounting for the expenditures on repairs.
Understanding what happens to earnest money when a buyer backs out is crucial for both buyers and sellers. Real estate attorneys play a vital role in negotiating these situations, achieving fair outcomes based on incurred costs and market conditions. By anticipating these issues and including clear terms in contracts, parties can mitigate disputes and protect their financial interests.
The Minchella & Associates Difference
With over 40 years of experience in Illinois real estate law, Erica Minchella has represented thousands of home sellers and buyers, landlords, and commercial and investment property owners. For more information, schedule a consultation today.
