Is a buyer’s deposit in an unconsummated real estate transaction refundable? As you may have guessed, it depends.
We deal with deposits every day. We deposit money in a bank. When we rent property, we provide our landlords with a security “deposit.” When we think of deposits in these contexts, we think of giving our money to a third party to hold, with the guaranty (at least the contractual guaranty) that we will get our money back at a later date when we want it, or, upon the occurrence of a future event. In the case of a bank, our money is held until we withdraw it. In the case of a security deposit, our money is held until we end our lease (assuming we have not damaged the premises).
When a party purchases real property, there will almost always be a “buyer’s deposit.” In residential transactions, a common buyer’s deposit is $5,000.00. Typically, this money is deposited in escrow (the third party in this instance) and held until the transaction is closed, in which case the deposit, along with the remainder of the purchase proceeds, are paid to the seller. In the event the transaction does not close and escrow is cancelled, the deposit does not automatically go back to the buyer, unless the seller executes an instruction to the escrow holder authorizing the refund.
In many residential purchases, the deposit is made into escrow immediately upon the signing of the contract. Residential purchases fail to close for many reasons and disputes often arise as to who is entitled to the buyer’s deposit. Many form real estate contracts in California provide that, in the event of a buyer’s breach of the contract, the seller retains the deposit as “liquidated damages.” The most simple definition of “liquidated damages,” is an amount agreed upon by the parties to be the sellers’ monetary damages, in the event the buyer fails to perform. These provisions are presumed valid in California, although this presumption is rebuttable. However, disputes invariably arise as to who breached the agreement and absent an agreement between buyer and seller following the termination of the transaction, the money will remain with the escrow holder until an agreement is reached or a lawsuit is filed.
Most disputes over the buyer’s deposit end up becoming a game of chicken between the buyer and seller. Fights over small deposits rarely justify the hiring of an attorney and/or the initiation of litigation. Moreover, if the parties cannot agree on who is entitled to the deposit, the escrow will have the option of filing a lawsuit called an “interpleader,” whereby it deposits the money in court (yet, another third party) and the entitlement to the deposit is decided by that court. The escrow company can reclaim its attorneys fees and costs for the interpleader from the amount deposited in court. If you are in one of these disputes and the deposit is small, say $5,000, it is advisable that you resolve the dispute over the deposit before it gets to the point where the escrow holder files suit.
Last year, the California Court of Appeal dealt with a case involving a buyer’s entitlement to the deposit. The case was called Kuish v. Smith (2010) 181 Cal.App.4th 1419. In Kuish, a buyer executed a purchase and sale agreement to buy a home for $14 million (chump change). The agreement provided that the buyer deposit $820,000 towards the purchase price and that the deposit was non-refundable. The buyer unilaterally cancelled the escrow (i.e., the buyer breached) and the seller immediately sold the property to someone else for $15 million. Even though the agreement provided that the deposit was non-refundable, the Court of Appeal ruled that the sellers’ retention of the deposits constituted an invalid forfeiture and ruled that the buyer was entitled to the funds. The court noted that the buyer’s breach occurred at a time when California was in an escalating real estate market, thus causing the seller no actual damages. It is uncertain how the Court of Appeal might have ruled if the sellers were unable to sell the property for a greater price after the buyer breached. The lesson to be learned from Kuish is that it is not always obvious who is entitled to the funds on deposit with escrow when a real estate transaction is cancelled. Kuish involved a large transaction, but most real estate transactions involve much smaller deposits.
When fighting over a small deposit, it is important to remember that most real estate contracts contain provisions that award attorneys fees to the prevailing party in a lawsuit. With this in mind, it is often better to compromise with the other party and split the deposit, even if you are certain you would prevail in the dispute. At the end of the day, you will still come out ahead.
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