EARNEST MONEY DISPUTES
IN TEXAS RESIDENTIAL TRANSACTIONS

Disputes over earnest money often arise when either buyer or seller perceive the other to be "at fault" for failing to close. The parties can become emotional and unreasonable. In fact, however, "fault" in the subjective sense is not the issue; the disposition of earnest money is expressly governed by the terms of the TREC One to Four Family Residential Contract and its addenda. Problems and the potential for litigation arise when an aggrieved party refuses to do what the contract says.

This article does not address what occurs when earnest money is not deposited at all, except to observe that this constitutes a breach of the contract (ie., a default by the buyer, as stated in the last sentence of paragraph 5). It does not, as some believe, cause the contract to fail altogether.

A common area of dispute is failure by the buyer to obtain financing. Note that although paragraph 4.A(1) makes the contract contingent upon financing, the Third-Party Financing Condition Addendum contains a blank for insertion of a specific time during which the buyer must notify the seller of his inability to obtain financing. If this notice is not timely given, the contingency is waived. Buyers often miss this detail and insist on their continuing right to get their earnest money back if they cannot obtain a loan.

Sellers, on the other hand, may believe that the buyer did not make a good-faith effort to get financing (as required by the Addendum) and therefore should not be entitled to return of the earnest money, even if notice is given within the prescribed period.

Whatever the cause of the dispute, paragraphs 18C through E address the procedure for release of earnest money:

Upon failure of the contract for any reason, the party desiring the earnest money must make written demand upon the title company. A copy of the demand should be sent to the other party. The written demand triggers a 15 day window during which the other party may make written objection to the title company. Phone calls, almost always legally insufficient in real estate for notice purposes, will not meet the requirements of the contract. Email or fax would be sufficient, but certified mail to both the title company and the other party is best, particularly if litigation is anticipated. There is nothing like being able to show a signed green card in court in order to prove notice.

The title company will follow-up with correspondence of its own notifying the other party that written demand for the earnest money has been made and enclosing a release of earnest money form for signature. It must be signed by all parties and their brokers, if any. Note that although 15 days is permitted in order to make written objection, paragraph D imposes liquidated damages of three times the amount of the earnest money if a party "wrongfully" refuses to sign a release within 7 days. Attorney's fees and costs could be added to this amount as provided in paragraph 17.

The language of the contract is vague about which demand - demand from the party desiring the earnest money vs. demand from the title company - triggers the 15 and 7 day periods, but it is prudent to be conservative and assume that these periods begin when the first party makes its written demand.

What happens next depends on whether or not the remedy of mediation was checked in paragraph 16. If so, mediation must precede the filing of any legal action to recover earnest money. Filing suit prior to mediation will likely result in the court abating the case (ie., putting it "on hold") until the mediation requirement is fulfilled.

Lawsuits may be filed in Justice Court so long as the total amount claimed (including attorney's fees) does not exceed $10,000 or, if total damages exceed that amount, in the County Court at Law. Named defendants should include the party refusing to sign the release and the title company holding the earnest money. Title companies will usually respond by interpleading the earnest money (ie., depositing the money into the court's account), removing them from the relative merits of the litigation. They may then seek to be dismissed from the case or stay in so as to recover their attorney's fees from the party at fault. Before taking legal action, it is useful to consider the practical reality that attorney's fees and costs, once added up, can easily exceed the amount of earnest money in dispute. As a consequence, many earnest money disputes are resolved by the parties' splitting the funds and going their separate ways.