Also see: Contracts Don’t Enforce Themselves (Re/Max of Boulder Podcast 10/20/15).
Question: A buyer put up five thousand dollars of earnest money and entered into a contract to buy a house. The buyer has a clear trail establishing that she valiantly pursued getting her loan, yet she couldn’t get financing. She timely exercised her loan contingency and properly terminated the contract. The contract provides for the return of the earnest money to the buyer after a proper termination. The neutral earnest money holder can’t release the funds to the buyer because the seller refuses to acknowledge contract termination. What can the buyer do to retrieve her earnest money? What can brokers do to avoid these problems for future buyers?
Answer: Contracts do not enforce themselves. When one party breaches a contract, a bolt of lightning does not emanate from the contract and strike down the breaching party. Regardless of the contract’s clarity and undisputed facts, some people (the seller in our example) flatly refuse to honor their clear contractual obligations (to release the earnest money, in our example). Sometimes the breaching party’s stubbornness cannot be overcome by his own attorney or a skilled mediator. Occasionally the non-breaching party (the buyer in our question) must sue to retrieve the earnest money.
Buyers, however, have options to reduce these risks. There is no “free lunch” with these options. They tend to make offers less desirable to the seller. Buyers must balance making their offers attractive versus the desire to avoid earnest money fights and other risks.
If the buyer puts up no earnest money, the buyer and seller can’t skirmish over earnest money 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 zero tolerance for earnest money fights, the only option is to have a contract without earnest money. Other options reduce the risk of earnest money hassles, but don’t eliminate all of the risks.
Slightly more attractive for a seller, a buyer might offer staged earnest money deposits. The buyer could propose $1,000 of earnest money payable upon execution of the contract (for example), with another $4,000 due after the buyer clears her due diligence contingencies.
The buyer might receive some comfort by having her earnest money held by someone aligned with the buyer. For example, the buyer’s agent can hold the earnest money rather than the listing broker. A friendly earnest money holder decreases the chance of an inadvertent (or intentional) release of the earnest money to the wrong side.
The agreement with the earnest money holder could remove the power of the seller’s passive/aggressive refusal to authorize refund of the earnest money by requiring the escrow agent 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. Filing a suit requires more tenacity. With a “sue or shut up” clause, the seller’s refusal to authorize earnest money release, might only briefly tie up buyer funds.
Occasionally, a provision providing that the breaching party pays the non-breaching party’s attorney’s fees moves the breaching party to honor the contract. Yet a “loser pays” attorney’s fees clause doesn’t move the irrational or impoverished seller and sometimes emboldens a party who doesn’t understand the weakness of his position.
Contracts do not enforce themselves. Sometimes parties who are clearly in the right have no choice but to sue to enforce the contract. We must all resist our natural expectation that we all honor the clear terms in our contracts.