Buyer’s Deposit: Keep or Return?

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There isn’t a week that goes by that I don’t receive a phone call from a potential client or their real estate agent asking if a buyer’s good faith deposit is refundable in a residential or commercial real estate purchase deal gone bad.

The short answer is “it depends.”

Most believe that so long as the buyer has not lifted any contingencies, he or she is always home free and is absolutely entitled to the release of their deposit upon cancellation of escrow.  At first blush, one would think “yes.”

Typically, the buyer who has exercised good faith in moving forward with conducting due diligence and discharging her duties pursuant to the purchase agreement and decides that she does not approve the inspection reports, is within her rights to cancel escrow and receive her deposit back.

Alternatively, the buyer who has diligently moved forward providing all of the required documents to his lender where the lender has declined to fund the loan based upon agreed upon terms, may be within his rights to cancel escrow pursuant to his loan contingency and demand the return of his deposit.

These scenarios assume no gamesmanship, deceit and a straight forward cancellation based upon good faith exercise of the appropriate contingencies.

Obviously, if the buyer has lifted any and all contingencies and moved toward the close of escrow but then later changes its mind and refuses to close, barring any extenuating circumstances or breach by seller of their duties, that buyer is most likely in breach of contract and would not be entitled to the return of their deposit.

If anything, it is the seller who may have suffered damages above and beyond the disputed deposit, including but not limited to carrying costs (principles, taxes, interest and other costs they would not have had to continue to pay had they closed escrow), decrease in property value, lost profit from an eventual sale at a lower price, lost opportunity in acquiring upleg property in a 1031 exchange.

However, there is a gray area of the law where a buyer who still has a contingency left open is arguably not only not entitled to the return of his or her deposit but may also be liable for fraud or misrepresentation –which then may expose the buyer to a claim for punitive damages.

Over the years, I have noticed a trend of buyers who have opened escrow, not lifted their contingencies but dragged their feet in escrow, not performed, made unreasonable or abusive demands upon the seller, submit a notice of cancellation and demand the return of their deposit.

Initially, it may seem that the seller is obligated to return this buyer’s deposit simply because the buyer is exercising their option to cancel pursuant to the appropriate contingency provision. Or are they?

It all depends on the specific facts of each case and the application of California law to those specific facts.

Upon a closer look at some files, I noticed that some buyers never conducted any physical inspections when the property was aged and inspections were warranted in order to discover what defects may exist that may not have been disclosed by the seller.

In this first category of cases, the buyer typically not only failed to conduct any physical inspections but also demanded an unreasonably high price reduction without providing any credible inspection reports all while alleging the property contained radon, asbestos and mold.

These buyers’ conduct effectively held the sellers’ properties hostage for several weeks or months when it was apparent that the seller would not give in to bullying tactics or reduce the price.  These buyer refused to lift contingencies or cancel escrow despite repeated Notices to Perform, Demand to Close Escrow, and Cancellation Notices having been served on the buyer.

Alternatively, some files disclosed a pattern of refusal by buyers to cooperate with their very own lender. For example, these buyers failed to provide their lender with easily obtainable supporting documentation so as to enable the underwriter who had already conditionally approved the loan to move forward.

Examples of supporting evidence include: copies of front and back of cancelled checks to prove certain reported expenses were accurate; an IRS transcript proving that a certain tax return was filed; W-2’s; bank statements proving that reported income was actually deposited; etc.

In this second category of cases, buyers had not lifted their loan contingency and moved to cancel escrow using the loan contingency.  However, a review of the file revealed the aforementioned conduct of refusal to cooperate with their lender which evidenced the buyer’s lack of intent to obtain a loan, fund and close escrow.

That certain buyer’s lack of intent to consummate a deal that they entered into can be tantamount to a fraudulent act perpetrated upon the seller, the agents and other parties who reasonably relied to their detriment upon the buyer’s stated promises and intentions in the purchase contract.

In my opinion, if no reasonable mutual negotiations were taking place and the buyer’s conduct meets certain requirements, that seller may have a potential claim for fraud among other torts. At that point, the buyer has jeopardized their deposit and is not entitled to its return.

Of course, if a seller has a back up buyer who’s willing, ready and able to pay the same price and maybe more to cover the seller’s losses, the seller may be willing to let the buyer off the hook and if both parties agree to cancellation, the seller can return the deposit.

However, if a buyer refuses to execute escrow cancellation which would then free up the property that this buyer clearly does not intend to purchase pursuant to the terms of the purchase agreement, the best approach is for buyer’s counsel to provide the following advice.

The buyer who has failed to honor the terms of the purchase agreement and has no defenses while seller has performed all her obligations, is best advised to sign the Escrow Cancellation and allow escrow to keep the deposit in trust pending mediation or litigation of the disputed deposit.

For a buyer to refuse to cancel escrow just because the deposit is at issue, does nothing but increase the seller’s damages and buyer’s exposure to legal and financial liability.

Therefore, simply because a buyer has refused to lift a contingency and kept it open as a loophole and not as what it was intended for, does not necessarily entitle that buyer to the full return of their deposit.  One must look at the totality of circumstances.

A seller may be entitled to not only keep the deposit but also to damages suffered as a result of the buyer’s breach of contract or other fraudulent conduct.

Finally, if a buyer has engaged in fraudulent conduct, a seller can agree to escrow cancellation and return of the buyer’s deposit so long as the seller does not sign any “release” of the buyer.

However, escrows typically always include “release and hold harmless” language for the seller and buyer to sign.

I strongly advise sellers who may have been victims of fraud to consult and attorney prior to signing a release of the buyer.  Seller can always agree to release the deposit without releasing the buyer and while reserving all of the seller’s rights to pursue a claim at the appropriate time.  But even that decision must not be made without the advice of a qualified real estate attorney.

This blog is not intended to and does not serve as legal advice. Please consult an attorney regarding the facts of your specific case before taking action.

Buyer’s Deposit and Broker Duties

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In my law practice, I often counsel buyers who are in escrow and can cancel escrow as they have not released some contingencies, but the Seller refuses to release the buyer’s deposit.

In California, if you are using the C.A.R. (California Association of Realtors) RPA (Residential Purchase Agreement) form, the buyer  can elect to have several types of contingencies.

In some cases, it may not be clear to a buyer or agent whether a particular “issue” is covered by one or two different contingencies.  This is where the buyer’s agent must discharge his or her Fiduciary Duty of Care, Diligence and Loyalty and advise the Buyer to either seek legal advice or not remove any contingencies until all due diligence items are clarified, lest they be in jeopardy of losing their deposit.

For example, let’s suppose you are a Buyer and you have made it clear to your agent that “square footage” of the house is very important for you. Your agent advises you to release your “physical inspection” contingency while you wait to release your “appraisal” contingency.   Let’s further suppose that you may not receive complete and accurate information regarding square footage until your appraisal report comes in, and you have not received the report yet.

How safe is it for you to remove your “inspection” contingency even if you still have your appraisal contingency open, despite your agent’s assurances to move forward with the sale?

The NAR and California Code of Ethics and the Standard of Care in California set the bar high for real estate agents and brokers, in terms of what their obligations are to their clients.

In California, Agents and brokers are held to be “fiduciaries.”   Under California law, fiduciaries are held to a very high standard much like “Trustees” of a trust.

In these circumstances, I believe that California’s “standard of care” and the law of fiduciary duty requires that a real estate agent not advise their client to lift contingencies rather protect their client by creating the necessary time and space for the client to receive, review and understand the ramifications of the material information obtained prior to lifting a contingency.

Creating this time and space, free from pressure, starts when a real estate agent is first drafting the offer. It continues in the “manner” in which the agent documents the client’s file so as to make the client’s subsequent requests be deemed “reasonable.”

Creating additional time may become increasingly difficult if the agent is a dual agent.  Dual agency is fraught with peril and covered in my other posts.

The best practice is to draft long enough contingencies and set them all to expire at the latest date possible, so as to avoid this type of scenario.

In this particular case, the appraisal contingency will not be the appropriate vehicle to use to cancel escrow due to square footage issues, if the buyer has already removed his “physical inspection” contingency.

 

Procuring Cause

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If you are a real estate Broker suing a Seller or another Broker over a real estate sales commission, or defending against such a claim, you deserve to be represented by a qualified real estate attorney.

Hire an attorney who is familiar with how the process works in your particular forum, not just with what real estate laws require –any attorney can look up the law.  Arbitration panels many not always follow case law.

Just as critical is an attorney who is aware of what precise evidence to develop, what questions to ask during the deposition/hearing/trial or Arbitration to increase your likelihood of prevailing.

I serve as an Arbitrator and regularly hear and decide commission disputes.

As a neutral decision maker, I sometimes see key evidence not being addressed by a party.  The Elephant in the room.  Evidence that could have helped them win the case. As a neutral, I am not allowed to advocate for any party.  All I can do is rule upon the evidence presented.

Buying a New Construction Condo or House?

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Buying a new construction house or condo? Over the years, savvy real estate agents have referred their buyers of new construction to my law office to review and explain the New Construction Purchase Agreement *before* their buyer signs the contract. That is because custom drafted New Construction Purchase Agreements contain terms very different from the C.A.R forms for the purchase of existing homes.

With the CAR Forms, agents can receive extensive continuing education training on how to interpret and navigate the forms. Whereas “Custom” drafted forms are drafted by the Developer’s real estate attorneys. I have yet to review two that were identical.

Every such custom drafted contract I have reviewed contains draconian terms that greatly restrict the buyer’s rights during and post close of escrow.

Said agreements are drafted by attorneys specifically hired by the Developer to protect the Developer seller against potential future claims brought by buyers. That attorney owes the Developer a fiduciary duty of care, including protecting them from exposure and liability for construction defect despite California laws seemingly drafted to protect consumers.

These contracts are NOT buyer friendly. I’ve seen buyers in dispute over their Deposit because they failed to object to an item or the contract had NO inspection contingency. Neither the buyer nor their agent picked up on the fact that the contract contained NO such contingency.

Most such custom contracts lack the generous terms and contingencies that the CAR forms offer.

For example, the current CAR purchase agreement for existing homes provides an “active” removal of contingencies, which means a buyer HAS their inspection and due diligence contingencies open until they actually remove them in writing. Did you know that it’s the exact opposite in most new home construction purchase agreements?

Agents owe buyers a fiduciary duty of care, which includes referral to a competent real estate attorney when faced with a brand new custom drafted Contract they have never seen before.

After all, you are purchasing an asset worth several hundred thousand dollars or millions.

Invest some time in researching an attorney familiar with this area of California real estate law and brokerage law. Retain one to protect your rights and guide you. The Seller already did.

New changes to California Residential Purchase Agreement Effective November 2014

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Neil Kalin, Assistant General Counsel of the California Association of Realtors (“CAR”), announced today that effective November 2014, the CAR will make available a newly revised form for the “Residential Purchase Agreement” (“RPA”).   www.CAR.org

The new C.A.R. RPA (California Association of Realtors’ Residential Purchase Agreement) contains many significant changes that buyers and especially their real estate agents and real estate brokers must now carefully navigate.  Approximately 75% of the new RPA contains changes, roughly half of the sub-paragraphs contain some revisions.

The C.A.R. revises this form to be responsive to the needs of California buyers and sellers of residential real estate.

I will be discussing certain of the material changes made to the CAR RPA in the next few weeks.

New Anti-Deficiency Protection for Refinance Loans Made After January 1, 2013

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Starting January 1, 2013, a new California law will protect homeowners who default on their refinance loans from personal liability for any deficiency following foreclosure. Existing anti-deficiency law protects a borrower from personal liability for the difference between the principal balance and what the lender receives at foreclosure if the loan is a purchase money loan secured by an owner-occupied property with one-to-four residential units. The new law, Senate Bill 1069, extends that anti-deficiency protection to include any loan used to refinance the purchase money loan, plus any loan fees, costs, and related expenses for the refinance. The anti-deficiency protection, however, does not extend to any “cash out” in a refinance, which is when the lender advances new principal not applied to any obligation owed under the purchase money loan. This new law does not affect the other anti-deficiency protections for non-judicial foreclosures (or trustee’s sales) and seller financing.

This new law only applies to refinance loans or other credit transactions used to refinance a purchase money loan, or subsequent refinances of a purchase money loan, that are executed on or after January 1, 2013. For purposes of this law, any payment of principal shall be deemed to be applied first to the principal balance of the purchase money loan, and then to the principal balance of any new advance and interest payments shall be applied to any interest due and owing.

C.A.R. supported Senate Bill 1069 in the legislative process as many homeowners do not realize that, by refinancing, they lose their anti-deficiency protection for a purchase money loan. Senate Bill 1069 is similar to Senate Bill 1178 sponsored by C.A.R. in 2010, but vetoed by Governor Schwarzenegger. The full text of the law is available at www.leginfo.ca.gov

Exculpatory Clauses in the California Real Estate Purchase Agreement Do Not Bar Claims By Buyers Of Real Property Alleging That The Seller’s Brokers Made Intentional Misrepresentations About The Property

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         Anne Manderville et al. v. PCG&S Group, Inc. et al. (2007) 146 Cal.App.4th 1486.  Here, the Court of Appeal determined that exculpatory clauses contained in a purchase contract are against public policy to the extent such clauses exempt any individual from liability for his own fraud and therefore do not bar a buyer of real property from showing that he justifiably relied on a broker’s intentional misrepresentation about the character of the property. The court also found that any lack of due diligence by a buyer in investigating zoning and other laws restricting the use of property, even if negligent, does not preclude the buyer from establishing justifiable reliance if (a) there has been an intentional misrepresentation; and (b) the purchase contract only permits, but does not require, the buyer to undertake his or her own due diligence.

Background:  Buyers agreed to purchase property to subdivide and build adjacent homes on. Buyers, through their agent, Fowler, found a multiple listing service (MLS) advertisement for property located in El Cajon, California. The listing stated in part that the 2.62 acre property could be split. However, Buyers and Fowler found a previous MLS listing for the same property that did not state that the property could be subdivided.  As a result of the discrepancy in the two MLS listings, Fowler contacted the Listing Broker (“Brokers”), and asked for confirmation that Buyers could indeed subdivide the property. During her deposition, Fowler testified that although she lacked a specific recollection of the Brokers’ answer, her handwritten notes made during the call indicated that the Brokers stated that the County of San Diego already approved a subdivision of the property to some extent and that a purchaser could subdivide the property. However, the Brokers knew that the county classified the property the property could not be subdivided.Several days after the telephone call, Buyers submitted an offer to purchase the property on a standard C.A.R. purchase agreement form.
The fully executed Agreement contained 3 exculpatory clauses: (1) paragraph 7 stated that Buyers had the “right” to conduct inspections and investigations and strongly advised Buyers to investigate the condition and suitability of all aspects of the property, including ordinances affecting the zoning and development of the property; (2) paragraph 26 contained an integration clause stating that the Agreement embodied all understandings with respect to the agreement and could not be contradicted by evidence of any prior agreement or contemporaneous oral agreement; and (3) a handwritten term from the seller’s counteroffer stating that “Buyer[s] to satisfy themselves to use of property with warranties or representation to use.”After the close of escrow, Buyers discovered that they could not subdivide the property because the general plan mandated a minimum lot size of 4 acres. Based on the representation of the Brokers that the property could be split, Buyers filed a claim against the Brokers alleging three counts of deceit for intentional misrepresentation, negligent misrepresentation, and suppression of facts. The trial court granted summary judgment in favor of the Brokers, finding that Buyers contractually assumed a duty to investigate limitations on the future development of the property and, as a matter of law, Buyers could not show justifiable reliance on the Brokers’ statements.

Exculpatory clauses in real estate purchase agreements do not prevent a buyer from showing justifiable reliance on a broker’s intentional misrepresentation.

               The Court of Appeal held that Buyers could maintain a claim for intentional misrepresentation notwithstanding the Brokers’ claim that the three exculpatory clauses in the Agreement prevented Buyers from showing that they justifiably relied on the Brokers’ misrepresentation that the property could be subdivided. The court noted that all contracts that exempt anyone from responsibility for his own fraud, willful injury to another, or violation of a law are against public policy. That the Brokers were not parties to the contract did not preclude the court from finding that the exculpatory clauses, as applied to the Brokers’ liability for their intentional misrepresentations, were invalid. Since the trial court had found that a fact-finder could reasonably determine that the Brokers intentionally misrepresented the feasibility of subdividing the property and that Buyers reasonably relied on this misrepresentation, the Court of Appeals found that summary judgment on Buyers’ intentional misrepresentation claim was inappropriate. A buyer’s failure to diligently investigate a broker’s representations does not bar a claim for intentional misrepresentation.

Finally, the Court found that Buyers’ negligence in investigating the Brokers’ misrepresentation that Buyers could subdivide the property did not bar their claim for intentional misrepresentation. The court noted that a plaintiff’s negligence in discovering the falsity of a misrepresentation is never a defense when the misrepresentation was intentional. Moreover, the court found that the purchase agreement did not impose a contractual duty on the Buyers to investigate whether they could subdivide the property, but instead only conferred on them the right to do so. Thus, Buyers’ failure to further investigate whether they could subdivide the property did not bar their claim against the Brokers for intentional misrepresentation.

A new California appellate case expands liability for real estate brokers

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Holmes v. Summer 188 Cal.App.4th 1510 (2010).

Prior to our current foreclosure debacle, I believe that this case may have come out differently. However, in this era of rampant foreclosures and upside-down properties, this ruling makes sense. The appellate court admits that its holding is based in part upon the current economic climate.  It stated that transactions like this one that are “doomed to fail” in a “downtrodden economy” when the public needs to have confidence in real estate agents and brokers.

Holmes v. Summer holds that if a real estate broker knows that a listed property is substantially upside-down and cannot be sold without a “short sale”, that broker has a duty to disclose to this material fact to a potential buyer. In this case, the buyer entered into a contract with a seller to purchase a house for $749,000. Then, the buyer (in reliance upon the sale) sells his own home to get the money to buy the new one, only to discover to his horror that the loans on the house total over $1.14 million, so the agreed upon purchase price won’t cut it. Holmes v. Summer, G041906 (Cal. App. 4th, filed Oct. 6, 2010). For the sale to have gone through, either the seller would have had to come up with the extra $392,000 or the various lenders would have agreed to write it off. Justice Moore writes “$392,000 is not exactly ‘chump change.”

Here, homebuyers sued the seller’s broker, claiming that the broker was under an obligation to disclose to the buyers that the property was over-encumbered and could not be sold at the agreed upon purchase price.

The Court of appeal reversed the trial court’s judgment sustaining the brokers’ demurrer to the complaint. The Court found that under the facts of this particular case, the brokers were obligated to disclose to the buyers that there was a substantial risk that the seller could not transfer title free and clear of monetary liens and encumbrances.

The seller’s broker argued that she had a duty not to disclose the seller’s confidential financial information. However, the court ruled that the existence of the three deeds of trust was public record and could be disclosed.

I believe that even though most competent brokers do disclose the existence of a short sale on the MLS and do use the C.A.R.’s “Short-Sale Addendum”, the risks and the details of the “short fall” in dollars are often not clearly communicated to buyers.

Thus, this decision expands broker liability.

The court now tells brokers they are “obligated to disclose to the buyers” when there is “a substantial risk that the seller [can] not transfer title free and clear of monetary liens and encumbrances.”

This ruling raises troubling issues for brokers and it will be interesting to see if the California Association of Realtors becomes involved in the case if it is appealed further.

For a copy of the court opinion please click here.