What Happens to the Deposit if Escrow Fails to Close?

Riverside, California (Westcoe Realtors)…In just about every purchase of a home, the buyer is asked to make a deposit as a sign of good faith to the seller that the buyer is actually serious about purchasing the seller’s home.  Once the buyer and seller reach an agreement on price and terms, this monetary deposit (no goats or chickens please) is deposited into a trust account (generally the escrow’s trust account…occasionally the brokers) and sits there until the escrow closes, at which point it is used as part of the buyers down payment or closing costs.  But, while no one ever plans for problems, what happens to the buyers deposit money if the escrow never closes?  Well, it depends…and that is why we are discussing this issue today.

FIRST, WHY HAVE A DEPOSIT AT ALL?  Why doesn’ t the buyer simply put all the money required to close the escrow in at the end, when the escrow is ready to close?  Well, technically, it could be done this way, but in the majority of sales (ok…99 out of 99) the deposit shows the seller that the buyer is truly serious about buying the sellers home.  Think about it.  The buyer is asking the seller to take his home off the market for anywhere from 30-60 days on the promise that the buyer can, and will, perform on the purchase.  When the seller’s home is off the market, the seller may be missing other potential buyers who now can no longer purchase this home…so the seller wants some assurance that the buyer is ready, willing, and able to complete this purchase.  Hence, a monetary deposit is the best way the buyer can demonstrate his good faith that he/she will perform on the purchase contract.

NEXT, WHERE DOES THE DEPOSIT GO?  Once the buyer and seller have reached an agreement, the majority of times, the deposit money is immediately deposited into the escrow trust account.  Its intended use is as part of the money the buyer will need to complete the purchase.  However, if the escrow fails to close, then as a neutral third party, the escrow holder will simply hold onto the money until someone tells them what to do with it (more on this below).

SO WHAT HAPPENS NOW IF THE ESCROW DOESN’T CLOSE?  Let us set aside for a moment a discussion of the myriad of reasons why an escrow can “fall out” and fail to close…and let us also set aside for now any determinations as to whose fault it is this property will not close.  In this discussion, let us simply look at the legal answer to the question of the deposit… for real estate law is very clear that once an escrow fails to close, there are only 3 ways the deposit can be released from escrow.

MUTUAL AGREEMENT OF BUYER AND SELLER…Pretty simple here.  The buyer and seller agree on where the money should go, and they sign in writing to this effect.  Once both parties agree on the dispensation of the money, escrow will cut a check(s) to wherever the principals have told it to.  Remember, escrow is a neutral third party by law, and therefore cannot make any determination on their own as to who should get the money.  The buyer can scream it belongs to them, and the sellers can do the same…and escrow may empathize with both, but escrow can do nothing without an agreement from both parties…and as long as both parties are claiming (sometimes quite loudly) that the money is “theirs”, then there is no mutual agreement, is there?  SO NOW WHAT?

JUDICIAL DECISION.  If the buyer and seller cannot agree on what should happen to the deposit money (no mutual agreement as discussed above), then most housing deposits fall in the jurisdiction of a small claims court action ($10,000 or less)…and as such, someone needs to take the other to small claims court.  It doesn’t matter who takes who, but in the end, someone needs to initiate the process of small claims.  Understand that if your deposit is $10,000 or less, then you must use small claims court…you cannot simply “sue” the other party in municipal court.  There is also a provision in the standard purchase contract that allows for an additional $1,000 penalty to the losing party in a small claims action if the court determines that “no good faith dispute exists” for refusing to release the deposit money….ie: simply being stubborn and refusing to mutually cancel the escrow when you really have no case may cost you an additional $1,000 in penalty fees, not to mention the court costs.  No matter what the reason, once the court has awarded a “judgement” to the prevailing party, then when that judgement is presented to escrow, escrow will follow the instructions on the judgement and cut the deposit check accordingly.

ESCROW GIVES THE MONEY TO THE STATE OF CALIFORNIA.  That’s right…this is not a misprint.  If the buyer and seller have not reached an agreement, and no one has taken the other to small claims court, then after 3 years, escrow is required by law to send the money to the State of Californian in a process known as “escheat”.  In theory, the State continues to try to mitigate an agreement between the buyer and seller, but good luck with that.  After 3 years, many times both parties are hard/impossible to find, and my own personal feeling is that the State “lip services” the effort to solve the problem, and then keeps the money for themselves.  Whatever.  In any case, it is now out of escrow’s hands, and off to the State.

As a final note to this process, I mentioned that we were avoiding a discussion about who should or should not get the money, and here is why.  In any fallout of escrow, it is generally fairly obvious who caused the problem and who did not…but sometimes, everyone is so irritated at the moment, or decides to take the fallout personally, that no one wants to cooperate.  Sometimes the issues were caused by one of the principals who is acting poorly or unprofessionally, sometimes the issues were unavoidable and were really no one’s fault.  Your standard purchase agreement has many clauses that help decide who is actually entitled to the deposit money in the event of a fallout, but since neither escrow nor the agents can legally make that determination on their own, someone needs to go to small claims court…and it is there the paperwork will assist the judge with whatever ruling is made.  The bottom line is that it is generally better for the buyer and seller to take a deep breath and try and solve the problem themselves…because small claims court is a crapshoot, or 3 years later, the State becomes a black hole in which money goes in, but perhaps never comes out!