Chapter 21. Earnest Money Procedures for Licensees INTRODUCTION

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1 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

2 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.

3 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, 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 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) (b) (c) (d) (e) the date is current, not postdated; the broker's name as payee is spelled correctly; the printed name on the check and the signature are the same; the address on the check is correct; and 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

4 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]

5 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 escrow/trust account within banking days 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

6 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.

7 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 re fund 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 s urrounding 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

8 closing statement, or ( 3) the earnest money is credited to the purchaser and deducted from the commission check the broker receives at the closing. (e) 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 c ontract 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 c laim 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

9 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,

10 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

11 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 fund s 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.