Chapter 21
Earnest Money Procedures for Licensees
INTRODUCTION
This chapter discusses the practices and the procedures that licensees must follow in
handling earnest money. This discussion of earnest money expands on the
discussion that appears in Chapter 18.
EARNEST MONEY DEFINED
Earnest money is the buyer's initial commitment of something of value to indicate a
serious desire to buy the property according to the terms of the offer being
submitted. Many people treat earnest money as a measure of the sincerity of the
buyer's interest and his or her ability to purchase.
THE PURPOSE OF EARNEST MONEY
Earnest money is not a legal requirement for a binding sales contract. The mutual
promises to exchange valuable assets given by the buyer and the seller provide the
legal consideration in a sales contract, and the agreement requires no additional
consideration.
However, the broker may request or the seller may insist that a certain amount of
earnest money accompany the offer. This point may be particularly important if
closing is to occur several months after the signing of the contract, but the
requirement exists in most contracts of any duration. The seller views earnest
money as a means to avoid the buyer's breach of contract. In addition, as discussed
in Chapter 6, earnest money can be liquidated damages retained by the seller and
the broker if the buyer does not close.
THE AMOUNT OF EARNEST MONEY
The amount of earnest money is a matter for negotiation between the parties. Some
brokers recommend buyers offer an amount based upon guidelines stated in the
firm's policy manual, or sometimes a seller will request a specific amount. The actual
amount of earnest money a buyer is willing to pay varies with the circumstances of
the transaction and the relative negotiating power of the parties. The size of the
buyer’s equity contribution or down payment requirement is one consideration. For
example, buyers applying for VA loans that require no down payment may offer
relatively little earnest money. On the other hand, commercial transactions can
involve large sums of money, so the amount of earnest money can be the subject of
intense negotiation. If the seller requests a certain amount of earnest money and a
prospective buyer's offer does not include that specific amount, the licensee must
still submit the offer to the seller promptly.
If the buyer pays a small amount of earnest money and later decides not to buy, he
or she may be more willing to forfeit the earnest money and walk away from the
contract. While the contract may still be legally binding, many sellers might not
want to go to the trouble of suing a buyer. A substantial earnest money deposit,
along with a liquidated damages provision in the contract, offers more protection
against the possibility of a buyer's breach of the contract. The contract must
carefully identify the manner in which the broker will disburse the forfeited earnest
money because Georgia courts dislike forfeitures and penalties.
THE EARNEST MONEY CLAUSE
Preprinted contracts typically include an earnest money clause such as the following:
Buyer has paid to the undersigned,
__________________ (“Holder”) $___________
check, or $
cash, receipt whereof is hereby
acknowledged by Holder, as earnest money, which
earnest money is to be deposited in Holder's
escrow/trust account and is to be applied as part
payment of the purchase price of said Property at time
of closing.
The wording of this and other contract provisions included in this manual are examples
only. Different transactions demand different language. Sales associates must seek
the approval of their brokers before using a stipulation from this manual in an actual
contract.
HANDLING OF EARNEST MONEY BY SALES ASSOCIATES
When a sales associate receives an offer and an earnest money deposit from a
prospective buyer, the law requires the associate to turn over the earnest money to
the broker as soon after receipt as practicably possible, which will vary according to
the circumstances and the broker's instructions. The manner in which a sales
associate properly gives earnest money to the broker is a policy his or her broker,
not the Commission, determines. Each broker must establish written procedures by
which their sales associates are to turn in earnest money and other trust funds.
Logically these written procedures would be part of the firm's policies and procedures
manual. The broker should have a specific procedure for handling cash deposits
since they involve different methods of security than do checks. The broker also is
responsible for instructing the sales associates on the office procedures for handling
earnest money and other trust funds.
EARNEST MONEY BY CASH OR CHECK
Earnest money is payable in cash, by certified check, by personal check, or at times
in the form of other valuable assets. An earnest money deposit in cash avoids
problems associated with personal checks such as the buyer having insufficient funds
in the account or stopping payment on the check, but cash deposits present sales
associates with additional problems. When there may be a delay before the licensee
can turn the money over to the broker, questions might arise concerning the amount
of cash received and possible improper use of the funds by the sales associate.
These questions, along with increased chances of loss, make cash a less desirable
form of earnest money.
A sales associate might be able to avoid taking a cash earnest money deposit by
accompanying the buyer to a bank, a post office, or a convenience store where the
buyer can buy a certified check or a money order. However, the sales associate
cannot take the cash and convert it to certified funds or to a money order, nor can
he or she deposit the cash earnest money into a personal account and then write a
check to the broker. A sales associate must not change the form of the deposit in
any way. Most preprinted sales contracts acknowledge receipt of the earnest
money. Thus, when the earnest money is in cash, the buyer's signed copy of the
offer will serve as a receipt.
When a broker receives a cash deposit of more than $10,000.00 in a real estate
transaction or in two or more related transactions, the Internal Revenue Service (IRS)
requires that the broker report the transaction on IRS Form 8300. The broker must
file the form with the IRS by the fifteenth day after the transaction occurs, give a
copy of the form to the person who paid the cash, and keep a copy of the form for
five years from the date of filing. A broker who fails to report the information or who
files a false or fraudulent report is subject to civil penalties and/or criminal
prosecution. Further information on this requirement is available on the IRS website.
If a personal check is the form of the earnest money, the buyer should make the
check payable to the holder, usually the listing broker, for deposit into that broker's
trust account. It is appropriate that the listing broker hold the earnest money since
that broker is the one directly responsible to the seller. Where the seller is not
represented by a broker and the buyer is, the same logic dictates that the buyer's
broker hold the earnest money. The sales associate must carefully examine the
check before taking leave of the buyer to turn it over to the broker. Among the
items to notice are that:
(a)
the date is current, not postdated;
(b)
the broker's name as payee is spelled correctly;
(c)
the printed name on the check and the signature are the same;
(d)
the address on the check is correct; and
(e)
the Arabic numerals for the amount of the check agree with the
written amount.
If anything about the check is unusual, such as being from a party other than the
buyer or being postdated, the offer should reflect that fact. As with cash, there are
potential problems with payment by personal check. The buyer can stop payment on
the check, or the check may not clear the bank for lack of sufficient funds in the
account. The seller can protect against these problems by making the contract
voidable at the seller's discretion if the check does not clear the buyer's bank
because of insufficient funds or a stop payment order. A clause such as the following
will afford the seller that protection:
In the event the Earnest Money check is returned
for insufficient funds or otherwise not honored by
the bank drawn upon and Buyer has not delivered
good funds to Holder within three (3) days of
bank's notice, then and in that event, the Seller in
his or her sole discretion shall have the right to
terminate this Agreement by giving written notice
to the parties.
The wording of this and other contract provisions included in this manual are
examples only. Different transactions demand different language. Sales
associates must seek the approval of their brokers before using a stipulation from
this manual in an actual contract.
EARNEST MONEY IN THE FORM OF PROPERTY ASSETS
Although rare, earnest money sometimes can be in the form of jewelry, automobiles,
stock, bonds, notes or personal services. In that event, the contract should clearly
describe the assets or services offered as earnest money, and the parties should
agree to the value of those assets or services to lessen the possibility of disputes
arising if the contract does not close. For example, a buyer may offer a specific
number of shares of common stock to be held until closing as a form of earnest
money. It is important for the parties to agree upon a method of determining the
value of such an asset since that value could change from the day it is tendered to
the day of closing or to a date that the contract might terminate. Other assets might
require an appraisal to determine their value.
When property or services are offered as earnest money, the following wording
might be useful to clarify its value for the contract:
The parties hereto
agree that the
Buyer shall provide
(or perform if it is a
service) the
following: [list the
assets or property
(or things to be
done if it is an offer
of service) to be
provided by the
Buyer]
Such items shall be
considered earnest
money in the
transaction at a
value of
$_______________
_
The wording of this and other contract provisions included in this manual are
examples only. Different transactions demand different language. Sales
associates must seek the approval of their brokers before using a stipulation from
this manual in an actual contract.
THE BROKER'S RESPONSIBILITIES FOR THE EARNEST MONEY CHECK
The law and the Commission insist that the public receive maximum protection when
licensees handle the funds of others. Therefore, the law and the Commission require
that the broker deposit immediately all earnest money and other trust funds into a
designated trust account unless the broker has written authority allowing deposit into
some other account or at some later time.
The prospective buyer is the only one with an interest in the earnest money until the
seller agrees to all of the terms of the offer. Therefore, if the buyer wants the broker
to hold the earnest money until all parties have agreed to the contract, the offer
must contain language giving the broker that instruction. To allow the broker to hold
the check until the offer is accepted or rejected, many preprinted contract forms
contain wording such as the following:
Buyer and Seller understand and agree that Holder
shall deposit the earnest money in Holder's
banking days
escrow/trust account within
following the Binding Agreement Date.
The wording of this and other contract provisions
included in this manual are examples
only. Different transactions demand different
language. Sales associates must seek the approval
of their brokers before using a stipulation from this
manual in an actual contract.
If a sales associate receives the earnest money check, he or she must give the check
to the broker as soon after receipt as is practicably possible since only the broker can
hold the check. Having instructions in the offer to hold the earnest money check will
help the broker avoid problems in refunding the earnest money should the seller
reject the buyer's offer and the buyer then ask for an immediate refund of the
earnest money.
If the contract has instructed the broker to hold the check pending acceptance of the
contract, the broker can accede to the buyer's request for a refund by giving back
the undeposited check. On the other hand, if the broker was instructed to deposit
the check immediately upon receipt, the buyer will have to wait several days for his
or her check to clear the bank since the broker must not disburse funds from the
trust account that are not on deposit in the trust account.
WHEN THE BUYER INSISTS THAT THE EARNEST MONEY BE DEPOSITED INTO
AN INTEREST-BEARING ACCOUNT
If the buyer is depositing a substantial amount of earnest money, and particularly if
closing is to be several months later, he or she might want the broker to deposit the
funds in an interest-bearing account. All parties having an interest in the funds must
agree to this procedure in writing and must specify which party or parties receive the
interest that the deposit earns. A typical preprinted contract for residential sales
may contain a clause similar to the following, giving the broker permission to deposit
the earnest money into an interest-bearing account and retaining the interest:
All parties to this agreement agree that
Holder may deposit the Earnest Money in an
interest-bearing escrow/trust account and
that Holder will retain the interest earned on
said deposit. Neither Buyer nor Seller shall
make a claim to any portion of the interest
earned on said deposit, regardless of to
whom or under what circumstances the
Earnest Money is ultimately disbursed.
The wording of this and other contract provisions
included in this manual are examples
only. Different transactions demand different
language. Sales associates must seek the approval
of their brokers before using a stipulation from this
manual in an actual contract.
THE BUYER GIVES A POSTDATED EARNEST MONEY CHECK
At the time of making an offer, a buyer might not have sufficient funds in a checking
account to cover an earnest money check. He or she may offer to give a postdated
check as earnest money and ask that the broker not deposit it until some later
date. It is generally a bad practice to accept postdated checks for earnest money
deposits. However, if a licensee accepts a postdated check, he or she must disclose
that fact to the seller in the offer including the date on the check and, if the licensee
is a sales associate, give the check to the broker promptly. A better alternative to
tendering a postdated check is for the buyer to give a smaller earnest money check
with the initial offer and to stipulate in the offer that the buyer will pay additional
earnest money on a specified date.
DISBURSING EARNEST MONEY
A broker who disburses earnest money from a designated trust account before there
is a contract properly fulfills his or her duty in the license law if the offer is rejected
or withdrawn. After a contract is formed, earnest money is generally not disbursed
until the contract is either terminated or closed. These and other circumstances are
discussed below:
(a)
UPON THE REJECTION OF AN OFFER - The buyer is entitled to a refund
of the earnest money if the seller rejects the offer.
(b)
UPON THE WITHDRAWAL OF AN OFFER - The withdrawal of an offer
before acceptance by the seller entitles the buyer to a full refund of
the earnest money.
(c)
UPON THE OCCURRENCE OF CONTINGENCIES IN THE CONTRACT Contingencies create the most frequent reasons a buyer may be due a
refund. Two common contingencies are the buyer's ability to obtain a
loan or to sell his or her present home. However, it is not the sales
associate's responsibility to decide whether the circumstances
surrounding a contingency entitle a buyer to a refund. That is solely
the broker’s decision.
(d)
AT THE TIME OF CLOSING - At the closing, the earnest money deposit
is part of the buyer's funds. The Georgia Real Estate Commission
requires the broker either to refund the earnest money or to credit it
to the buyer's account at closing. The broker and closing attorney will
determine the specific way they want the earnest money handled at
closing. Among the possibilities are:
(1)
the broker refunds the money directly to the
purchaser,
(2)
the broker brings the earnest money to closing in the
form of certified funds for deposit in the attorney's
escrow account and disbursement according to the
closing statement, or
(3)
(e)
the earnest money is credited to the purchaser and
deducted from the commission check the broker
receives at the closing.
WHEN THE CLOSING DOES NOT OCCUR - Once the seller accepts the
buyer's offer, both parties have an interest in the earnest money. The
broker is then acting as trustee for both parties with respect to those
funds. Preprinted sales contracts usually indicate the disposition of
the earnest money if either the buyer or the seller fails to close
without a valid reason. The broker then has responsibility of deciding
(often with the help of competent legal counsel) what the contract
may require regarding disposition of the earnest money. The broker's
resolution to this problem depends on many statements and
conditions appearing in various sections of the contract.
Most sales contracts provide that the earnest money is liquidated
damages to the seller and the broker when the buyer breaches the
contract and fails to close the transaction. At this point, the funds are
in the broker's possession, and both the seller and the broker have a
claim against these funds. The broker and the sales associate have
expended time, effort, and money for advertising and showing the
property. The seller has lost time and opportunities by taking the
property off the market. The seller may also suffer a financial loss if
the property value declines from what it was when the contract was
signed. The actual distribution of the funds requires an agreement
between the parties that is often incorporated into the language of the
contract as in the following example:
Buyer
agrees that
if Buyer fails
or refuses to
perform any
of Buyer's
covenants
herein,
Buyer shall
forthwith
pay Broker
the full
commission
immediately
; provided
that Broker
may first
apply onehalf of the
earnest
money
toward
payment of,
but not to
exceed, the
full
commission
and may pay
the balance
thereof to
Seller as
liquidated
damages to
Seller, if
Seller claims
balance as
Seller's
liquidated
damages in
full
settlement
of any claim
for
damages,
whereupon
Broker shall
be released
from any
and all
liability for
return of the
earnest
money to
Buyer.
The wording of this and other contract provisions
included in this manual are examples
only. Different transactions demand different
language. Sales associates must seek the approval
of their brokers before using a stipulation from this
manual in an actual contract.
When a contract fails to close, it is good practice for the broker to
attempt to get a termination and release agreement signed by all
interested parties before disbursing the earnest money. In so doing,
the broker offers the parties better protection of their interests and
helps to avoid possible litigation. The sales associate may need to help
in this process by seeking to get the buyer and seller to sign a
release. If the buyer and seller refuse to sign the release and the
broker still wishes to disburse the funds, the broker has the following
alternatives:
(1)
FILE AN INTERPLEADER ACTION - If the contract fails to close
and the broker is unable to get all parties to agree in writing
as to how the earnest money should be disbursed, the broker
may in some cases ask the court to decide who receives the
earnest money. This would be done by the broker initiating
an interpleader action and depositing the funds with the
court.
(2)
COURT ORDER - If parties claiming trust funds held by a
broker litigate their claims, the broker must disburse the
funds according to the order of the court. In this case, where
the parties rather than the broker have initiated the court
action, the funds would remain with the broker unless the
broker is ordered to deposit the funds with the court while
the litigation is pending.
(3)
REASONABLE INTERPRETATION OF THE CONTRACT - If the
parties to a contract cannot agree in writing who should
receive the earnest money, the broker holding the trust funds
may disburse the funds after making a “reasonable
interpretation of the contract.” Before making such
disbursement, a prudent broker will consult with an attorney
for advice in determining to whom to disburse the
funds. (See Section 6.30 of this manual, "Special Problems
Disbursing Trust Funds.")
Whatever the circumstance, a broker must not disburse funds from the firm’s trust
account until the broker has reasonable assurance that the bank has credited the
funds to the account. Moreover, when a broker makes a disbursement to which all
parties to the contract do not expressly agree, the broker must immediately notify all
parties in writing of the disbursement. The contract may require this notice be given
a certain number of days prior to the disbursement.
DISBURSING EARNEST MONEY FUNDS IN A MANNER CONTRARY TO THE
CONTRACT
A broker who disburses earnest money from the firm's trust account contrary to the
terms of a contract will be considered by the Commission to have demonstrated
incompetency to act as a real estate broker in such manner as to safeguard the
interest of the public. In such instances, the Commission may impose a strong
sanction against the broker and its license.