Can Earnest Money Deposits Be Made “Nonrefundable”?

Posted on by Phil Querin

Earnest Money Deposits Generally. The term “earnest money” has been historically used to refer to the “deposit” paid by buyers that accompany an offer to purchase real property. Metaphorically, it is intended to show the buyer’s “good faith” intent to complete the purchase. Most written agreements provide that the earnest money will be forfeited to the seller should the buyer default under the terms of the contract. If the transaction fails for reasons unrelated to the buyer’s nonperformance, the earnest money deposit is normally refunded.

OREF Sale Agreement. The OREF Sale Agreement is no different. There are several buyer contingencies in the Agreement, e.g. for bank financing, appraisal, inspection, and if applicable, for inspection of the private well and septic/drain field.  If any one of them fail to occur during the agreed-upon inspection period, the buyer’s earnest money deposit will be refunded, and the transaction terminated.

The Agreement provides that when escrow opens a transaction, the earnest money is to be deposited into its trust account, and not released before closing except upon written instructions of the seller and buyer.

Lastly, it is important to know that under the OREF Sale Agreement, forfeiture of the deposit is the seller’s only remedy upon a buyer’s default. This means that sellers must be prudent in setting the amount of the earnest money, since a small deposit that could be easily forfeited right before closing, might have little effect in keeping a buyer committed to closing the transaction.

Making the Earnest Money Deposit Non-Refundable.  Notwithstanding the terms of the OREF Sale Agreement, sellers occasionally insist that the earnest money deposit be “non-refundable” and released to the seller prior to closing. Since there is no provision in the Sale Agreement for early release of the deposit, it falls to the parties or their brokers, to write something for escrow to follow; and even then, escrow will normally supplement the parties’ instruction with a printed form for them to also sign.

Why would a seller insist on making the earnest money deposit non-refundable?  In new construction, this is not uncommon. In the view of many builders, the larger the deposit, the greater the buyer’s commitment is to remain in the transaction.

In the sale of existing homes, if it is a “seller’s market” (i.e. there are more buyers vying for a smaller inventory of homes) some sellers demand the deposit be made “non-refundable” simply because they can. And in some instances, sellers may require it because they believe they will be significantly damaged should their buyer default – say because the seller has already committed to purchase another home.

 The Conundrum. Unfortunately, when parties agree to make the deposit non-refundable, it is not uncommon for the broker to simply write an Addendum to the Sale Agreement saying:

Buyer and Seller agree that the earnest money deposit shall become non-refundable and immediately released to Seller.

However, simply calling the deposit “non-refundable” may not be so simple. Why? Because there are several other sections of the Sale Agreement expressly saying that if certain events occur, the deposit “shall” be refunded to the buyer. For example:

5.2 FAILURE OF FINANCING CONTINGENCIES: If Buyer receives actual notification from Lender that any Financing Contingencies identified above have failed or otherwise cannot occur, Buyer shall promptly notify Seller, and the parties shall have        business days (two [2] if not filled in) following the date of Buyer’s notification to Seller to either (a) Terminate this transaction by signing an OREF 057 Termination Agreement and/or such other similar form as may be provided by Escrow; or (b) Reach a written mutual agreement upon such price and terms that will permit this transaction to continue. Neither Seller nor Buyer are required under the preceding provision (b) to reach such agreement. If (a) or (b) fail to occur within the time period identified in this Section 5.2 (Failure of Financing Contingencies), this transaction shall be automatically terminated, and all earnest money shall be promptly refunded to Buyer. Buyer understands, upon termination of this transaction, Seller shall have the right to place the Property back on the market for sale upon any price and terms as Seller determines, in Seller’s sole discretion. (Italics and underscore mine.)

Here is another example:

EARNEST MONEY REFUND TO BUYER: If (1) Seller does not approve this Agreement; or (2) Seller signs and accepts this Agreement but fails to furnish marketable title; or (3) Seller fails to complete this transaction in accordance with the material terms of this Agreement; or (4) any condition which Buyer has made an express contingency in this Agreement (and has not been otherwise waived) fails through no fault of Buyer, then all earnest money deposits shall be promptly refunded to Buyer. However, acceptance by Buyer of the refund shall not constitute a waiver of other legal remedies available to

Does simply calling the deposit “non-refundable” in an Addendum, have the effect of nullifying the clear language in Sections 5.2 and 27.2 of the Sale Agreement of which it is a part?

The term “Addendum” means “something to be added” Black’s Law Dictionary 31 (7th ed. abridged 2000); See, also, Oregon Association of Realtors®, Mutual Agreement Addendums:

“When used to make modifications to an existing contract, mutual agreement addendums do not normally affect the formation, validity or enforceability of the underlying contract. Typically, mutual agreement addendums propose a modification that may be accepted or rejected by the other party without calling into question the existing agreement between the parties.” https://oregonrealtors.org/rmt_article/mutual-agreement-addendums/

Thus, use of an Addendum, by its own terms, is intended to “add” a certain provision to the Sale Agreement. However, if the Addendum does not say the Sale Agreement is to “amended”[1] would that mean Sections 5.2 and 27.2 remain in effect?   But that would mean that interpreting Sale Agreement and the Addendum together, the earnest money is both refundable and nonrefundable. This is the classic definition of an ambiguity, i.e. a writing that is susceptible of at least two alternative constructions.

To put a fine point on this conundrum, by saying the word “non-refundable” applies across the board to all events, even though they were not identified, would require that one ignore Sections 5.2 and 27.2 even though the Addendum made no such mention of them. Thus, buyer would lose their deposit, even though:

  • Their bank did not approve the loan – something over which the buyer had no control;
  • The property did not appraise at least for the sale price of the home – something over which the buyer had no control;
  • Seller could not deliver marketable title – something over which the buyer had no control;
  • Seller refused to close the transaction – something over which the buyer had no control;

Clearly, this was not something contemplated by the parties at the time the Addendum was drafted and signed.

Typically, when amending a written contract, good drafting requires that the amendment expressly state what part of the Sale Agreement is to be changed, added, or deleted, and what part is to remain. If that is so, using an Addendum stating simply that the deposit is to become “nonrefundable” without more, is insufficient.

 How Courts Deal With Ambiguity. Once a document is determined to be ambiguous, the court will permit the introduction of “extrinsic evidence”, i.e. evidence outside the four corners of the writing, to explain the circumstances of the change.

From a lawyer’s point of view, the drafter of the document has failed, since the goal in all cases, is to create a document that is clear on its face. Opening the door to extrinsic evidence to interpret the document can be a free-for-all, where all parties can point to outside events and  statements, supporting their own favored interpretation.

The Take-Away. The use of the word “non-refundable” standing alone, is capable of multiple interpretations – most of which were likely never considered by the parties when the Addendum was drafted.

  • It could mean non-refundable for all purposes, except seller’s default. Thus, if the buyer’s lender did not approve the loan, the deposit will not be refunded;
  • It could mean non-refundable for all purposes, including seller’s default, which seems unreasonable, although there is nothing to clarify it.
  • It could mean non-refundable except where a buyer contingency occurs, in which case the deposit will be refunded.

Had any of these circumstances been considered, they would have likely been addressed at the time. Accordingly, proactive drafting is encouraged. This means:

  • Don’t add an addendum or amendment to the Sale Agreement without making sure it will not contradict or make ambiguous, another provision;
  • Even if it doesn’t affect the terms of the Sale Agreement, is it clear on its face?
  • Does it require further explanation to be understood?
  • Are there alternative provisions that are shorter?
  • Would a third party (who is unfamiliar with the issue) interpret the change the same way as you?  ~ Phil 

__________________________________

[1] “Addendum: something to be added” Black’s Law Dictionary 31 (7th ed. abridged 2000); See also, Oregon Association of Realtors, Mutual Agreement Addendums, “When used to make modifications to an existing contract, mutual agreement addendums do not normally affect the formation, validity or enforceability of the underlying contract. Typically, mutual agreement addendums propose a modification that may be accepted or rejected by the other party without calling into question the existing agreement between the parties.” https://oregonrealtors.org/rmt_article/mutual-agreement-addendums/

Posted in Broker Risk Management, Legal Drafting, Miscellany, Real Estate General, Real Estate Laws, Realtor Risk Management, Residential Housiing
  • Categories

  • Archives