Earnest Money – the Good, the Bad and the Ugly

“earnest-money-check"Earnest Money – it’s good when we have it, it’s bad when we don’t and it’s ugly when the buyer and seller are fighting over it.  Let’s take a look at the life cycle of earnest money in order and discover where the dangers of a high noon shootout are…

When to Get It

The 2016 KCRAR Sales Contract included provisions mandating when a buyer had to provide the seller with the agreed upon earnest money under the Sales Contract.  Under Section 4(a), the earnest money can either be provided with the Contract; or within 2 calendar days from the Effective Date of the Contract.  Considering the percentage of contract offers submitted electronically, option 2 is likely going to be used more often.  Prior to 2015, there was no deadline for getting the earnest money to the seller but in theory, the buyer was in default the moment there was an effective Sales Contract but no earnest money.  As a result, sellers were often confused on when they could demand it from the buyer or when they could threaten to cancel the contract.  Now, unless a different number of days is inserted into Section 4(a), it’s 2 days from the effective date.  When representing buyers, keep in mind that failure to timely get the earnest money to the seller can result in the seller terminating the contract per Section 20(a) of the 2016 Sales Contract.

When to Deposit It

For starters, these deadlines are what the respective States mandate but for practical purposes the deadline to deposit the earnest money should be AS SOON AS POSSIBLE!  One, you don’t want to risk tucking the check in your desk, or between your car seats – you haven’t even vacuumed out the fries that fell down there, do you really think you are going to find that check that gets lost.  So, the moment it touches your hand get it to the office staff or the title company as the case may be.  But, in case you do care about the deadlines imposed by the States, they are: Missouri – within ten (10) banking days from the effective date of the Sales Contract; and Kansas – within five (5) business days from the effective date of the Sales Contract.

*Notice, these 10 and 5 day deadlines are not running from when the seller actually received the earnest money check, but rather the effective date of the contract – so if it takes 2 days to get the monies from the buyer, you are now down to 8 and 3 days to get it deposited.

Missing these deadlines are the easiest license law violations to detect during audits by the Real Estate Commissions.  So, there is no hiding the ugly when this gets missed.  Another reason for getting the earnest money deposited quickly is the fact that the process for clearing a check is still a rather long process.  Even in this age of technology and the 21st Century, it can take 10-14 days to receive final confirmation of a check clearing – you don’t want to be two plus weeks into the transaction and have to tell your seller the buyer’s check didn’t clear (what are the chances if they bounce an earnest money check that they will have fund to buy the rest of the house …)

The Ugly – When to Fight Over It

Let’s assume the Sales Contract is not going to close and the parties are disputing to whom the earnest money should be paid out to. Neither the real estate brokerage nor title company in possession of the earnest money is permitted to act as the “judge” and decide whether buyer or seller gets the funds.  Many buyers and sellers are under the mistaken impression that simply because their agent’s brokerage is holding the earnest money, they can ultimately make the determination on which party receives the money.   The distribution of earnest money is controlled by Section 20 of the Sales Contract.

Section 20 of the Sales Contract

  • Starting Presumption: If the Sales Contract is terminated by any express provision (contingencies, inspections, resolutions .. etc.), the buyer gets the earnest money.
  • Exception: To override the starting presumption that the buyer gets the earnest money, must look to: (1) an exception in the Sales Contract; or (2) a mutual agreement between the buyer and seller.   The exceptions to the presumption that the buyer is entitled to receive the earnest money are set forth in Section 14(b) of the Sales Contract.  That section notes the seller’s remedies when a buyer defaults under the Sales Contract.
  • Mutual Consent:In Section 20 of the Sales Contract, the buyer and seller agree that the escrow holder cannot release the earnest money without the written consent of all parties.  (NOTE: This is the language that you show your client when they are demanding the earnest money and they want to know why you will not pay the earnest money out to them … “because Mr. and Mrs. Seller/Buyer, you agreed that I couldn’t”).  If the parties agree to the manner of distributing the earnest money and sign the Mutual Release and Cancellation Agreement, or some other form they provide, the earnest money can be released as directed in the document.

What if There is No Mutual Consent – The REALLY Ugly

Option 1: The escrow holder can initiate an “interpleader” action, which simply means the escrow holder commences a lawsuit, naming both buyer and seller and the earnest money is deposited with the Court, and the escrow holder tells the Court there are multiple parties making a claim to the earnest money, and its the Court’s responsibility to determine who is entitled to the proceeds.  This option is usually not very attractive, because the escrow holder is entitled to receive its costs and fees for filing the interpleader from the earnest money being deposited with the Court.  This reduces the available funds eventually available for the buyer or seller, so an interpleader is typically only commenced when a large sum is at stake.

Option 2: In the absence of a known dispute AND no mutual consent between the buyer and seller for distributing the earnest money, the escrow holder can send a certified letter to the parties stating to whom the earnest money will be paid to.  The receiving party has 7 days in Kansas / 15 days in Missouri to respond in writing disputing the release of earnest money in the manner stated in the certified letter.  Failure to respond within those timeframes = consent to a release of the earnest money per the certified letter.  Like Option 1, this option’s availability is limited, and only applies to those transactions where one party has become unresponsive, disappeared or is not stating an objection to a release of the earnest money to the other party, but simply won’t sign the proper cancellation form.

Option 3: If the buyer and seller cannot mutually agree to the manner in which the earnest money should be released, and both parties have made a claim to all or a portion of the monies (a known dispute, therefore Option 2 is not available), the buyer and seller may need to resolve the issue before a Court.  Depending on the amount of the earnest money, small claims court may be an available forum to litigate the dispute.  Each Counties’ small claims process has different limits on controversies that can be filed: In Johnson County, Kansas ($4000 and under); In Jackson County, Cass County and Platte County Missouri ($3,000 and under).  Parties typically represent themselves in small claims proceedings, without the assistance of an attorney, and the filing fees are customarily under $50.00.  Small claims offers a relatively quick and efficient manner of presenting the earnest money dispute to the Court and receiving a ruling determining whether the buyer or seller is entitled to the earnest money.  Once an Order is entered by the Court, the escrow holder may distribute the sums in accordance with the directions of the Court’s Order.  If the earnest money in dispute, is greater than the amounts stated above for small claims court, the buyer and seller would be required to litigate the matter in traditional District and Circuit Court, which is more expensive and lengthy.  (Note:  Section 14 of the Sales Contract states that the non-defaulting party is liable for the other party’s legal costs and expenses).

Ok – What You’ve Been Waiting For – the Quick and Dirty Cheat Sheet For Distributing Earnest Money

Earnest Money to Buyer

  1. When parties consent in writing; OR
  2. Order from a Court directing that buyer is entitled to the earnest money; OR
  3. No known dispute and seller does not respond to certified letter within 7 (KS) / 15 (Mo) days

Earnest Money to Seller

  1. When parties consent in writing; OR
  2. Order from a Court directing that seller is entitled to the earnest money; OR
  3. No known dispute and buyer does not respond to certified letter within 7 (KS) / 15 (Mo) days

The bottom line is that both the real estate agent and brokerage must remain neutral in earnest money disputes and if the buyer and seller cannot mutually resolve the dispute, they should be advised to seek independent legal advice.

Written by Chris Kelly
Chief Administrative & Legal Officer
ReeceNichols Real Estate, Corporate