Whose Money Is It Anyway? Q&A On Handling Earnest Money Disputes

August 1, 2016

Q: The Seller terminated the contract and delivered a Cancellation of Contract, Release of Deposit and Joint Escrow Instructions (“CC”) to the Buyer, providing that the earnest money deposit (EMD) be released to the Seller. Buyer refuses to sign it. Seller believes that the Seller is entitled to the EMD. Why won’t the escrow officer release the EMD without a CC signed by both parties?

A: An escrow agent is a neutral third party in the transaction and cannot act upon a unilateral request by either a seller or a buyer to release the EMD. Since the escrow agent is a neutral third party, the escrow agent cannot decide who is entitled to receive the EMD. Neither the Residential Purchase Agreement and Joint Escrow Instructions (“RPA”) nor California law give an escrow agent the authority to become a judge and listen to each party's side of the story and determine who is entitled to receive the EMD. If an escrow agent did make such a factual and legal determination, that escrow agent would have breached their fiduciary duties and could be subject to a "breach of fiduciary duty" lawsuit by the party who lost the EMD.

Q: Now the Buyer has delivered a CC to the Seller. The CC states that Buyer should receive back his EMD. The Seller refuses to sign this version and everyone is arguing with one another. What should a Buyer or Seller do?

A: Contact an attorney to discuss your legal rights and obligations. A Realtor has no duty to get involved in a disagreement over the EMD. A Realtor’s only duty is to point out the contract terms, to assist with the preparation of the CC, and to circulate it to the correct parties (and possibly to give testimony in court or an arbitration about the transaction). It is the obligation of the Buyer and Seller to ensure that all funds deposited into an escrow account are returned to the person who deposited the funds or who is otherwise entitled to the funds under the RPA. (Civil Code section 1057.3) Sellers and Buyers should read Paragraph 14G and Paragraph 18B(x) of the RPA. If Paragraph 21B is checked, Sellers and Buyers should also read Paragraph 21B.

Q: Is there any way one party can force the other party to sign a CC?

A: Maybe. If both parties refuse to sign the CC, one party can sign and deliver to the escrow officer the CC along with either the Buyer Demand for Release of Deposit (BDRD) or the Seller Demand for Release of Deposit (SDRD). If the other party does not object within ten (10) days of the escrow officer serving the BDRD or the SDRD on the other party, then, at the escrow officer’s discretion, the escrow officer may release the EMD to the requesting party. Each party should be aware that the RPA states that if a Buyer or Seller refuses to sign the CC without a good faith dispute over who should receive the EMD, then that party will be subject to a civil penalty. The Buyer and Seller should know that the party who fails to sign the CC to release funds, or any other document presented by the escrow agent to release funds, within 30 days, shall be liable for the amount of the EMD withheld in bad faith and a fine up to $1,000.00. (Civil Code section 1057.3) Perhaps pointing out that language in the RPA might motivate the other party to sign the CC or to negotiate a split of the EMD.

Q: What happens next to determine who gets the earnest money?

A: Read Paragraph 22 of the RPA. The California Association of Realtors offers a mediation program to resolve disputes (http://www.car.org/mediation/consumers/). Buyers and Sellers can always agree to participate in mediation regardless of the amount of money involved. Nonetheless, if the EMD in dispute is more than $10,000.00 (the Small Claims limits), the parties are required to first attempt to resolve their dispute in mediation. If the amount of the EMD in dispute is less than $10,000.00, the client can start a small claims action against the other party. The judge or commissioner appointed to the case will decide who is entitled to the EMD and will issue a judgment.

Q: Will the title company then release the earnest money to the party who wins in court?

A: The judge will issue an Order directing the escrow officer to release the EMD as decided by the judge. The escrow officer will comply with that Order and release the EMD as directed.

Q: I don't want to go through the time and expense of suing the other party. Is there any alternative?

A: The only other obvious alternative, if neither party wants to go through the expense of going to court, is to agree on some kind of compromise to split the money. Neither side will probably be completely satisfied with the compromise, but it beats nobody receiving any of the EMD.

Q: If the parties never go to court and a BDRD or SDRD was not used, what will happen to the earnest money?

A: The escrow agent will interplead the money. An interpleader is a court action where the escrow agent gives the money to the court and has the court decide who gets the money. (Code of Civil Procedure Section 386). If the escrow agent needs to start an interpleader action, the escrow agent is entitled to its court costs and attorneys’ fees for the interpleader action. These costs and fees will be taken out of the earnest money being held.

Q: If I still have questions, what should I do?

A: Contact the Law Office of Kristina M. Reed.