Earnest Money Not Forfeited on Failure of Real Estate Contract

It is commonly known that earnest money is a deposit made by a buyer towards the purchase of real estate to demonstrate that the buyer is serious in wanting to complete the purchase. If the seller accepts the buyer’s offer, the earnest money is generally held in escrow until closing and is then applied to the buyer’s portion of the remaining costs associated with closing the contract. If the buyer retracts the offer, the buyer forfeits the earnest money. If the offer is rejected, the earnest money is usually returned, since no binding contract was entered into. Likewise, if the contract is made conditional on the buyer receiving acceptable financing (or some other condition), the failure of the condition to be satisfied generally does not cause the earnest money to be forfeited. This case involved a real estate purchase contract that contained ambiguous language. The issues were whether the language created a condition and, if so, whether the buyer forfeited the earnest money.

The defendants attempted to sell its business, a Supper Club, at auction. The auction was open only to cash buyers. Before the auction, the plaintiffs told the defendants that they were interested in the property, but couldn’t participate in the auction because they weren’t cash buyers. The auction was held, but the defendant rejected the high bid as being too low. So, the defendant started talking to the plaintiff again about purchasing the property. The parties reached an acceptable price, and the plaintiff provided $25,000 as earnest money. The contract stated that the earnest money deposit would be forfeited as liquidated damages if the plaintiff failed to perform according to the terms of the contract. The defendant wanted the plaintiff to assume the defendant’s existing mortgage on the property, and including language in the purchase contract stating that, “Buyer to qualify for and assume first Mortgage…”. The plaintiff, before giving the $25,000 earnest money to the defendant asked whether the money would be returned if the contract didn’t go through. The defendant’s representative stated that it would.

Unfortunately, the bank told the parties that the mortgage could not be assumed unless the defendant remained on the loan as a borrower. The parties tried to work out an acceptable arrangement, but ultimately the contract could not be completed and the defendant retained the earnest money. The plaintiffs sued to get it back.

The trial court held that the earnest money should be refunded to the plaintiff because the contract couldn’t be completed due to a “financing contingency.”  On appeal, the Court of Appeals affirmed. The court determined that the clause in issue was ambiguous and had to be construed in light of the circumstances surrounding the contract negotiations. As such, the court reasoned that the ambiguous language was a condition precedent. That meant that the failure of the condition to be satisfied voided the contract, and the plaintiff was entitled to the return of the earnest money. Budde v. 3 Putt, L.L.C., No.7-155/06-1546 (Iowa Ct. App. April 25, 2007).