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.