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Do We Still Need Earnest Money?

By MNR News posted 12-13-2023 12:54 PM

  
Once it was a way for buyers to show serious interest in purchasing a home. Now it’s often at the center of bitter disputes when transactions fall apart. Is earnest money worth the hassle?

Earnest money has become a very confusing topic for buyers, sellers, and Realtors® over the past several years. In fact, we field an increasing number of questions on the Legal Hotline about the law and ethics of properly handling, and eventually distributing, earnest money. That’s because to some degree, our understanding of earnest money has shifted. In the past, it was a way for buyers to assure a seller they were serious about purchasing a property. As a show of good faith, they were willing to risk losing the money if they failed to complete the purchase.

However, buyers weren’t completely out on a limb. To protect their interests, the Minnesota Realtors®’ (MNR) Forms Committee drafted contingencies into purchase agreement forms that allowed for canceling the purchase agreement and refunding the buyer’s earnest money. Typically, these were related to a sale of buyer’s property, financing, and inspections. These contingencies, along with a seller default, allowed refunding the buyer’s earnest money if a contract was canceled. Otherwise, if a buyer backed out of a contract for any other reasons, the earnest money was retained by the seller.

Today, buyers’ perceptions about purchase agreements have changed. Many now expect their earnest money will be refunded no matter what. Even if they simply change their minds about buying the property. As always, anything can be negotiated in a contract and sometimes a seller benefits more from quickly canceling and refunding the earnest money. But it begs the question; why bother collecting earnest money at all?

Another issue is whether a purchase agreement still binds both parties if the earnest money is not received in the time stipulated by the contract. MNR’s purchase agreement contract states, beginning on line 447, that: 

 Receipt of earnest money is not required to fully execute the document. So, if earnest money is not received on time per the purchase agreement, the contract is in breach but not void. To be clear, this does not mean it’s okay to fail following through on a contract. In fact, this breach is a basis for a seller to declare the purchase agreement canceled and seek a signed cancellation or begin a statutory cancellation process.

Lastly, we have seen several scenarios where the terms of the purchase agreement end the contract. For instance, let’s say the contract is contingent on the buyer obtaining financing. But when the closing date rolls around, the buyer’s loan has fallen through. Further, no extensions have been agreed to in an amendment. Under these terms, the contract is canceled and the buyer and seller must sign a cancellation that refunds the buyer’s earnest money or directs it to the seller—whatever course the parties agreed upon. It’s very important to be aware that although the contract has ended, the earnest money cannot be released from a trust account unless one of these four documents are obtained per Minn. Stat. § 82.75  

(1) Closing of the transaction; 

(2) Written agreement between the parties; (signed cancellation directing money to a party) 

(3) Pursuant to an affidavit as required in section 559.217; (Statutory Cancellation) or 

(4) Court order 

If you release the earnest money to a party before having one of these four documents, you, as the holder of the trust account, will be in violation of state statute. This, of course, is not a desirable outcome. 

While we can debate the value of earnest money in the contemporary real estate market, there’s little doubt it will remain a fixture in transactions for years to come. To protect yourself, your brokerage, and your clients, you need to understand all its legal, ethical, and contractual dimensions. As you can see, conflicts over earnest money can quickly escalate in the wake of a canceled purchase agreement. Although we’ve covered some common scenarios here, the course of action might not be clear in every case. That’s why it is always best to consult with your attorney if you are uncertain about how to proceed, both legally and ethically. 

This article appeared in the November/December 2023 issue of The Minnesota Realtor® magazine.

To read it in our digital magazine, click here.

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