Disputes over earnest money usually arise when either buyer or seller perceives the other to be at fault for failing to close in a timely manner. The parties can be emotional, unreasonable, and determined to stand on principle, all common shortcomings in persons who may threaten to file lawsuits but are unacquainted with the costs and burdens of litigation. Usually “fault” is not the issue, at least as to earnest money, since its orderly disposition is expressly governed by the TREC 1-4 contract and its addenda. Problems and the potential for litigation most often arise when a party refuses to do what the contract says.
This article does not address what occurs when earnest money is not deposited at all, except to observe that this constitutes a breach (a default) by the buyer in the case of an otherwise valid and accepted earnest money contract. Failure of the buyer to perform in this regard does not, as many believe, cause the contract to fail altogether.
Buyer Withdrawal Because of Failure to Obtain Financing
A common area of dispute is the buyer’s inability to obtain financing. Note that the TREC Third Party Financing Addendum contains a blank for a specific time during which the buyer must notify the seller of his inability to obtain financing. If this notice is not timely given, the contingency is waived. Buyers often miss this detail and insist on their continuing right to get their earnest money back if their loan application is denied, even after the specified time has run.
Sellers, on the other hand, may believe that the buyer did not make “every reasonable effort to obtain credit approval” (as required by the TREC addendum) and therefore should not be entitled to return of earnest money even if notice is given within the prescribed period. Unfortunately for this point of view, the addendum does not go into detail about what “every reasonable effort” means.
Contract Provisions Relating to Release of Earnest Money
Whatever the cause of the dispute, paragraphs 18.C through E address the procedure for release of earnest money:
C. DEMAND: Upon termination of this contract, either party or the escrow agent may send a release of earnest money to each party and the parties shall execute counterparts of the release and deliver same to the escrow agent. If either party fails to execute the release, either party may make a written demand to the escrow agent for the earnest money. If only one party makes written demand for the earnest money, escrow agent shall promptly provide a copy of the demand to the other party. If escrow agent does not receive written objection to the demand from the other party within 15 days, escrow agent may disburse the earnest money to the party making demand reduced by the amount of unpaid expenses incurred on behalf of the party receiving the earnest money and escrow agent may pay the same to the creditors. If escrow agent complies with the provisions of this paragraph, each party hereby releases escrow agent from all adverse claims related to the disbursal of the earnest money.
D. DAMAGES: Any party who wrongfully fails or refuses to sign a release acceptable to the escrow agent within 7 days of receipt of the request will be liable to the other party for liquidated damages in an amount equal to the sum of: (i) damages; (ii) the earnest money; (iii) reasonable attorney’s fees; and (iv) all costs of suit.
E. NOTICES: Escrow agent’s notices will be effective when sent in compliance with Paragraph 21. Notice of objection to the demand will be deemed effective upon receipt by escrow agent.
The contract is clear. Upon failure of the contract for any reason, the party desiring the earnest money must make written demand upon the title company. A copy of the demand should be sent to the other party. The written demand triggers a 15-day window during which the other party may make written objection to the title company. Phone calls, almost always legally insufficient in real estate for notice purposes, will not meet the requirements of the contract. Fax? Maybe. Email or text might be sufficient, since Texas is gradually recognizing the legitimacy of these forms of communication, but certified mail to both the title company and the other party is always best, particularly if litigation is a possibility. There is nothing like being able to show a signed green card to a judge in order to prove that notice was given. Send another copy by first class mail.
The language of the contract is vague about which demand—demand from the party desiring the earnest money versus demand from the title company—triggers the 15- and 7-day periods, but it is prudent to be conservative and assume that these periods begin when the first party makes written demand.
What happens next?
The title company will follow up with a notice of its own that written demand has been made and enclosing a release form for signature. It must be signed by all parties and their brokers. Fifteen days are allowed for written objections to be made.
The TREC contract formerly made the choice of mediation elective in paragraph 16. There is no longer a “yes or no” box to check on the latest form of this contract, so mediation is now required as a means of settling disputes—unless this paragraph is either struck and initialed or a special provisions addendum is attached that deals differently with dispute resolution. Generally, including a mediation requirement is a favorable provision for the seller, less so for the buyer.
Lawsuit Remedy in Justice Court
Lawsuits may be filed in justice court so long as the total amount claimed (including attorney’s fees) does not exceed $10,000. If total damages exceed that amount, then suit may be filed in the county court at law. Named defendants should include the party refusing to sign the release and the title company holding the earnest money. Title companies will usually respond by interpleading the earnest money (depositing it into the court’s account) which removes them from the merits of the litigation. The title company may then seek dismissal from the case or decide to remain in an attempt to recover attorney’s fees from the party at fault.
Before filing a legal action concerning earnest money, it is useful to consider the practical reality that attorney’s fees and costs, once added up, can easily exceed the amount of earnest money in dispute. As a consequence, many earnest money disputes are resolved by the parties’ splitting the funds and going their separate ways, respective claims of principle notwithstanding.
Can you avoid earnest money disputes by imposing a liquidated damages penalty?
The idea here is that the contract would contain a liquidated damages clause to be applied in the event the seller refused to release the earnest money, something sufficiently harsh to discourage a seller from withholding these funds. A clause such as this would have to be included in a special provisions addendum. In Magill v. Watson, 409 S.W.3d 673 (Tex.App.—Houston [1st Dist.] 2013, no pet.), the court disallowed such an arbitrary treble-damages penalty because it was not rationally related to any actual damages that the buyer would suffer. It left open, however, the possibility that such a clause would be enforceable if the provision reflected a reasonable assessment of what the buyer’s damages would be.
Information in this article is provided for general educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well since we are not tax practitioners and do not offer tax advice. This firm does not represent you (i.e., no attorney-client relationship is established) unless and until it is retained and expressly agrees in writing to do so.
Copyright © 2019 by David J. Willis. All rights reserved. Mr. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, www.LoneStarLandLaw.com.