Earnest Money Disputes

By Mark J. Bainbridge 

These days, there are many issues that can kill a deal. With the prevalence of short sales, foreclosures and other non-traditional transactions it can be very difficult for brokers to keep a deal together through closing. Buyers back out for many reasons and sometimes no reason. When they do, there may be significant earnest money in dispute. Whether the seller or buyer "breached" the purchase agreement and who is entitled to the earnest money is often hotly contested.

The Law

Most earnest money disputes will be governed by the contract itself. If you are using the Arizona Association of Realtors' standard purchase contract, Sections 3&7 address earnest money disputes. Generally speaking, the escrow company is instructed to only disburse earnest money in accordance with the terms of the contract. If a dispute arises, Section 7 will govern the dispute resolution procedure discussed below. Also, general common law principles of contract interpretation will apply. These may include such principles as ambiguous provisions in the contract or addenda being construed against the drafter of the language, specific terms controlling general terms, waiver, and mutual mistake of fact. There are many others, but it is important to consult an attorney to determine which principles may apply to your dispute.

Mediation

The AAR contract does generally require that buyer and seller mediate before taking any legal action. This can be done through a private mediator and/or through the AAR Dispute Resolution System. Once a mediator is agreed upon, the parties will proceed with mediation and should make an honest effort to resolve their dispute. The mediator's fees will usually be split evenly by the parties. It is important to note that many other potential parties (i.e. not buyer/seller) are not necessarily bound by the mediation provision or obligated to attend. Sometimes other parties may choose to attend mediation if they know they are likely to be named as a party if the case progresses.

Arbitration and Litigation

If mediation is unsuccessful, then the parties will proceed toward arbitration of their dispute. However, either party may opt out of arbitration and proceed with a lawsuit if done within 30 days of the conclusion of mediation. There are a variety of strategy and cost considerations that come into play when deciding between arbitration and litigation. But both the buyer and seller essentially have a veto over arbitration as either can opt out and proceed with litigation if so desired.

Cost Considerations

I am a proponent of meditation and settlement whenever possible. Many earnest money disputes are simply not cost effective to litigate. That is, it will cost the parties more to litigate than the amount in dispute. Even if the amount in dispute is high, it may still make sense to settle. There is an old saying that "a bird in hand is worth two in the bush". I believe that buyers and sellers should be cognizant of the certainty settlement can bring, even if neither party gets exactly what they want. Before deciding on any course of action, it is important to seek appropriate legal advice from a licensed attorney.

Mark J. Bainbridge is the founder of The Bainbridge Law Firm, L.L.C., a real estate and business litigation firm in Scottsdale. Ph: 602-274-6369.