Earnest Money Disputes and Resolution

Earnest money disputes are triggered by several common scenarios: the buyer claims a valid contingency exit while the seller alleges the contingency was not properly invoked; the buyer walks away from the transaction without exercising a contingency and the seller claims the earnest money as liquidated damages; the parties disagree about whether changed conditions (such as discovered defects or title issues) constitute valid grounds for cancellation; or both parties claim responsibility for a missed deadline that resulted in the transaction failing.

The root cause of most earnest money disputes is ambiguous contract language. When the contract does not clearly specify the conditions under which earnest money is refundable or forfeitable, both parties can argue in good faith that they are entitled to the deposit. Prevention requires clear, specific contract provisions that leave no room for interpretation.

Most real estate purchase agreements include a dispute resolution provision specifying the process for resolving disagreements. Common mechanisms include: direct negotiation between the parties, mediation (a neutral third party facilitates agreement), arbitration (a neutral third party renders a binding decision), and litigation (court adjudication). Many contracts require mediation as a prerequisite to litigation or arbitration.

When earnest money is held in escrow and a dispute arises, the escrow agent (typically the title company or brokerage) has a duty to hold the funds until receiving either mutual instructions from both parties or a court order directing disbursement. The escrow agent should not unilaterally disburse disputed funds to either party. If the dispute cannot be resolved, the escrow agent may file an interpleader action — depositing the funds with the court and asking the court to determine the proper recipient.

Prevention is far more effective than resolution. Best practices include: defining every contingency with specific exercise procedures and deadlines, specifying whether each contingency uses passive or active approval mechanics, including a clear liquidated damages provision specifying that earnest money is the exclusive remedy for buyer default, documenting all contingency exercises and waivers in writing, and including a mediation-before-litigation requirement in the contract.

Additionally, agents should verify that earnest money is deposited promptly (within the timeframe specified by contract and state law), maintain a record of the deposit including the check number or wire reference, and communicate with the escrow agent throughout the transaction to ensure proper custody. If a transaction appears headed toward failure, agents should proactively discuss the earnest money implications with their clients and begin working toward a mutual release before positions harden.