Is earnest money really important?
Posted on 03/28/2017 at 12:00 AM by William Serangeli
In today’s world of interstate transactions, real estate professionals are often put in the situation of submitting to Sellers’ agents purchase agreements/offers to buy for Buyers who either live out of state or some distance from the location of the home being marketed. With surprising frequency, the Buyers either forget to transmit the earnest money deposit after the acceptance of the purchase agreement/offer to buy or hold off in paying the earnest money deposit until there is a demand by Sellers’ agent that the earnest money be paid.
Often the Sellers are confronted with a subsequent offer and seek guidance as to whether or not the Sellers are bound to perform the first offer since the earnest money was not paid.
The standard purchase agreement/offer to buy has language similar to that set forth below:
“Purchase Price: The Purchase Price shall be $+++++++ and the method of payment shall be as follows: $++++ with this offer: and $++++ as earnest money upon acceptance of this offer, etc.
The issue is “What is the legal effect of the Buyers’ failure to pay the earnest money deposit?” Unless the purchase agreement/offer to buy contains a statement similar to this:
“Purchase Price: The Purchase Price shall be $+++++++ and the method of payment shall be as follows: $++++ with this offer: and $++++ as earnest money upon acceptance of this offer, which shall be paid within 3 days of the acceptance of this offer, which if not paid within this 3 day time period shall make the Sellers’ acceptance null and void without any further action of the Sellers or notice to the Buyers”
or there has been added to the other provisions paragraph of the purchase agreement/offer to buy language that:
“..the earnest money must be paid within 3 days of the acceptance of this offer. The failure to pay the earnest money within this 3 day time period shall make the Sellers’ acceptance null and void without any further action of the Sellers or notice to the Buyers.”
there is still a legally binding contract for the sale of the property, with both the Sellers and Buyers being bound to perform the purchase agreement/offer to buy. The Sellers are not at liberty to accept any subsequent offers without that acceptance being conditioned upon the termination of the first offer and the release of the Sellers from performance of the accepted first offer, i.e., standard back up offer protocol. Nor are the Buyers free to walk away claiming no contract existed. The reason for this is that the earnest money deposit is normally so inconsequential when compared to the aggregate purchase price, that the failure to pay the earnest money does not provide either the Sellers or the Buyers with a mechanism to avoid performing the contract.
Surprisingly this issue permeates today’s real estate market, although the applicable law with regard to this matter is now established precedent for 31 years and set forth in Kirsterin Development Co. v. Garanson Investment, 394 N.W.2d 325 (Iowa 1986). In Kirsterin, the Iowa Supreme Court affirmed a decision of the Court of Appeals. The significance of the Kirsterin opinion is that a clear distinction was made between a failure of consideration and a lack of consideration.
A failure of consideration does not prevent the formation of a contract, whereas a lack of consideration may do so. A failure of consideration may sometimes serve as a defense to the enforcement of an existing contract. Id. at 331, citing Union Story Trust and Savings Bank v Sayer, 332 N.W.2d 316, 322-23 (Iowa 1983). The alleged failure of consideration ordinarily must be total to serve as a complete defense to a breach of contract claim. Id. Under Iowa law, a written, signed agreement is deemed supported by consideration and the party challenging the contract has the burden to prove a lack of consideration. Id.
Kirsterin makes it clear that consideration may take many forms. In Kirsterin the offer and acceptance contained mutual promises as consideration to support an agreement. The buyer promised to pay $600,000.00 in exchange for the seller’s promise to transfer the property. This was the real consideration in the contract. As stated by the Iowa Supreme Court, the Court generally will not inquire further into the adequacy of the consideration. Id. at 331-332.
What was persuasive to the Kirsterin court was that the $100.00 earnest money was a part of the buyer’s $600,000.00 consideration for the purchase. The record contained no evidence that the seller’s agent ever attempted to collect the money from the buyer after the seller accepted the offer. The Iowa Supreme Court specifically declined to explore the issue as to whether a waiver of the earnest money requirement had occurred by holding that the failure to pay a $100.00 earnest money commission out of a $600,000.00 contract price could not constitute a total failure of consideration. Consequently, the failure to pay the $100.00 earnest money deposit could not serve as a total defense to the plaintiff’s contract action. Id. at 332.
In Kirsterin the seller’s final contention was that the written offer was too incomplete as a matter of law to even constitute an enforceable contract. The Iowa Supreme Court agreed with the Court of Appeals that the record contained sufficient evidence to generate a jury issue on that claim. The Iowa Supreme Court cautioned that it makes every effort to avoid holding as a matter of law that an agreement is too uncertain or incomplete to constitute a contract. Id., citing Palmer v. Albert, 310 N.W.2d 169, 172 (Iowa 1981).
The Union Story Trust and Savings Bank v. Sayer, 332 N.W.2d 316 (Iowa 1983) decision referenced in Kirsterin is of importance for in that decision the Iowa Supreme Court dealt with the failure of consideration defense. In addressing that contention, the Iowa Supreme Court held “just as is in the case of an alleged breach of condition which the contract itself does not establish to be a condition precedent to performance, an alleged failure of consideration must ordinarily be total in order to be a complete defense to the return performance of the other contracting party. Id. at 322.
Because modern real estate practice normally dictates that only a nominal earnest money deposit be made by the Buyers and the purchase agreement/offer to buy contains no automatic cancellation remedy for the failure to pay the earnest money deposit, a valid contract should be presumed to exist between the Sellers and Buyers when the nominal earnest money deposit is not made. When this factual circumstance occurs, the Sellers and the Buyers should be directed to discuss the legal effect of the nonpayment with their own independent legal counsel and standard back up offer protocol should be followed in the continued marketing of the Sellers’ property.
The material in this blog is not intended, nor should it be construed or relied upon, as legal advice. Please consult with an attorney if specific legal information is needed.
- William Serangeli
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