An earnest money deposit (EMD) is the money that a Buyer puts down to demonstrate their “good faith” or seriousness about buying a particular home. If the Buyer defaults on or cancels the contract, this EMD serves as liquidated damages, in part to compensate the Seller for the time, expense, and effort expended on that transaction and/or required to secure new buyers. Shortly after the contract to buy/sell a particular property is entered into, the EMD is paid to a third party (“Escrow Agent”), typically the title company handling the closing.
EMDs are not required, but it is customary to see an EMD of about 1% of the purchase price in Northern Virginia residential real estate transactions. For context, an EMD of 1% on a home with a purchase price of $600,000 would be $6,000. In a highly competitive market, Buyers may offer a much higher EMD to make their offer stand out and more attractive to the Sellers. Most contracts specify the timeframe within which the EMD must be delivered to the Escrow Agent. Once received, the Escrow Agent will hold the EMD until the date of settlement, at which point the EMD will be applied towards the Buyers’ down payment and/or closing costs.
So what happens to the EMD if one of the parties default and/or wish to void the contract? This is where real estate professionals may unwittingly get it wrong. Real estate professionals may simply tell their clients if the Buyer terminates the contract for any of the reasons or contingencies allowed under the contract, the EMD will be returned to the Buyer. If the Buyer fails to perform for any other reason, the EMD goes to the Seller. While not wholly inaccurate, it is an oversimplification that results in unrealistic expectations and angry clients in the event of a dispute.
Although distribution of the EMD appears straightforward, it is multifaceted in practice. To understand why, we have to look at the contract language. Most contracts spell out the conditions under which the Escrow Agent can release the EMD. In the Northern Virginia Association of Realtors (NVAR) Residential Sales Contract (“Contract”)1, the relevant language can be found in paragraph 3. Deposit, of the January 2022 revised edition. It states:
Deposit will be held in escrow until: (i) credited toward Sales Price at Settlement; (ii) all Parties have agreed in writing as to its disposition; (iii) a court of competent jurisdiction orders disbursement and all appeal periods have expired; or (iv) disposed of in any other manner authorized by law.
If a dispute occurs and one of the parties wishes to cancel the agreement, Paragraph 3(ii) thru (iv) outline how the EMD will be handled. Per this contract language, regardless of the reason for the cancellation, the Escrow Agent cannot release the EMD except (a) in accordance with a written release signed by both parties; (b) in accordance with a court order; or (c) as otherwise authorized by law.
Accordingly, even if the Buyer terminates the agreement by properly exercising a contractual right to void – whether it be pursuant to a financing contingency, a home inspection contingency, or some other term in the contract – the Escrow Agent cannot release the EMD to either party without an agreement signed by both Buyer and Seller, or a court order. The Escrow Agent is not in a position to determine whether the Buyer or the Seller is entitled to the EMD. That decision will depend on the interpretation of the specific language in the contract between the parties and circumstances for the termination – a job best left to a judge or jury. Please note, if the Escrow Agent is a Real Estate Broker, there is an additional avenue available for release of the EMD under Real Estate Board regulations. NVAR has a great explanation of these conditions in their article which can be found (here).
Having said that, it is very rare for a dispute to occur as parties are usually able to present a signed release, like NVAR’s Release of Sales Contract, to the Escrow Agent. Cultivating and maintaining a cooperative relationship throughout the transaction can set Buyers and Sellers up for greater success in resolving unforeseen issues, such as EMD disputes, should they arise. Note, a party that unreasonably refuses to release the EMD faces increased exposure to legal action for improperly withholding the release of funds. But before turning to the legal system for a resolution, parties should consider the time and expense involved in a lawsuit. More often than not, the negotiation required to identify an agreeable arrangement results in a more time and cost-effective resolution and release of the EMD. An acceptable compromise might result in the Buyer walking away with most, but not all of the EMD; the Seller walking away with most, but not all of the EMD; or the parties splitting the EMD evenly. By informing Buyers and Sellers of these possibilities upfront real estate professionals can help their clients form realistic expectations and be better prepared in the event of a dispute.