A mutual demand

Sometimes, despite the best efforts of a broker or agent, real estate sales transactions fall apart.

When a sales transaction fails to close, the buyer and seller need to provide mutual instructions for an escrow to disburse the buyer’s funds. This is based on the right of the buyer and seller to cancel escrow instructions without also cancelling the purchase agreement. When the purchase agreement is cancelled, the buyer and seller no longer have the right to pursue claims against one another in the failed transaction. [See RPI Form 401-5]

Typically, escrow holds the buyer’s good faith deposit toward the payment of the purchase price of a one-to-four unit residential property. When escrow fails to close due to the nonperformance of either the buyer or the seller — a breach of the underlying purchase agreement — any funds held in escrow are to be disbursed within 30 days after the person entitled to the funds demands them.

However, when a demand by one participant for receipt of the funds is disputed by the other participant, the resolution depends on who has the right to receive the funds. [Calif. Civil Code §1057.3]

When the escrowed funds are the buyer’s good faith deposit toward payment of the purchase price. A seller or buyer who unjustifiably refuses to release the buyer’s good faith deposit within 30 days of demand for the funds is liable for:

  • a money penalty of three times the amount wrongfully withheld, called treble damages, an amount to be greater than $100 but less than $1,000; and
  • attorney fees.

The seller or buyer is exposed to liability for these amounts when they:

  • interfere with the release of escrowed funds; and
  • do not have a good faith, reasonable legal basis for making a claim on the funds. [CC §1057.3(b)(2)]

Within 30 days after the first demand received by escrow for the funds, the buyer and seller are individually obligated to:

  • determine who is entitled to the funds; and
  • hand escrow cancellation and release of funds instructions to clear the deposits out of escrow.

Some outdated purchase agreements contain boilerplate forfeiture-of-deposit provisions a seller might wrongly use to claim they are entitled to a deposit. Here, the seller is not entitled to any of the buyer’s funds unless the seller has suffered out-of-pocket money losses due to a breach by the buyer. [CC §1675(b)]

When a buyer breaches the purchase agreement, the seller still needs to consent to the release of the escrowed deposit to the buyer, less any unrecovered, out-of-pocket money losses the seller actually incurred due to the buyer’s breach.

When escrow does not receive mutual instructions to disburse funds within 30 days of a unilateral demand, the escrow company simply deposits the funds with the court, called an interpleader. On deposit with the court, escrow is no longer responsible for the funds. Escrow then closes out its trust account on this sale’s escrow. [Calif. Code of Civil Procedure §386; Security Trust & Savings Bank v. Carlsen (1928) 205 C 309]

Related video:

Good faith and bad faith — beyond real estate morality

A legitimate good faith dispute may exist between the buyer and the seller over entitlement to the buyer’s deposit when a transaction fails to close. [CC §1057.3(f)(2)]

The good faith standard for a participant’s refusal to release escrowed funds requires the participant to hold a reasonable belief they have the right to the funds. However, on resolution of a good faith dispute, neither the buyer nor seller is entitled to any penalty or statutory attorney fees. [CC §1057.3(c)]

Only when the seller has actually sustained out-of-pocket money losses on transaction-related expenditures, or the property’s value has declined below the agreed price by the date of the buyer’s breach, may the seller properly demand money. When the seller has experienced no related money losses, any such demand is without legal basis.

Even when a buyer breaches the purchase agreement, they are still entitled to a refund of their entire good faith deposit when the seller incurs no money losses due to the breach. Further, a seller who refuses to release the buyer’s deposit and cancel escrow instructions based on the buyer’s breach has acted in bad faith. The seller needs to document they have suffered a transaction-related money loss to be entitled to the funds.

In the event the seller has suffered no such loss, the seller has 30 days following the buyer’s written demand for the return of the buyer’s funds to instruct escrow to release the funds to the buyer regardless of breach of purchase agreement. Otherwise, the seller may be subject to a civil money penalty and attorney fees. [CC §1675(c-e)]

Money losses a seller might incur on a buyer’s breach include:

  • lost rent caused by the terms of the sale;
  • a decline in the property’s value below the agreed-upon price;
  • transactional expenses unrecoverable when the property is resold; and
  • other expenditures directly related to the transaction which will go uncompensated. [CC §1675(e)]

Consider a transaction which fails to close due to a buyer’s breach of the purchase agreement. The seller instructs escrow to disburse to the seller a portion of the buyer’s deposit equal to their money losses. Escrow will deduct its cancellation charges and return any remaining funds to the buyer.

The buyer is requested to sign the disbursement instructions which include cancellation of escrow, but not of the purchase agreement. [See RPI Form 401-5]

The seller also provides the breaching buyer an itemized accounting of money losses incurred on the sale. [See RPI Form 401-6]

The buyer refuses to sign the instructions. Instead, the buyer demands the seller sign conflicting instructions releasing the entire deposit to the buyer and calling for the cancellation of both the escrow instructions and purchase agreement. [See RPI Form 181]

Here, the buyer does not have a good faith, reasonable legal basis for a claim to all the funds deposited into escrow.

When the dispute continues for more than 30 days after the seller instructs escrow to disburse the funds, the seller may file a money action for:

  • release of the portion of the deposit equal to the seller’s money losses;
  • a civil penalty of up to $1,000 against the buyer; and
  • attorney fees. [CC §1057.3(b)]

However, the seller needs to document the money losses they have demanded from the buyer’s deposit. A buyer may challenge a demand from a seller who fails to provide documentation of their actual money losses. [CC §1675(c)]

When the seller does not provide documentation, the buyer will escape penalties and attorney fees by showing they acted in good faith when disputing the release of funds demanded by the seller.

Cancel escrow and enforce the purchase agreement   

The primary function of these rules is to distance escrow from buyer-seller disputes over funds held in escrow, since escrow officers are not in the business of mediating disputes between transaction participants.

To that end, cancellation of escrow on the release of funds does not cancel the underlying purchase agreement. By canceling escrow but not the purchase agreement, the rights of either party to litigate any past or future performance of the purchase agreement remain entirely intact. [CC §1057.3(e)]

For example, a buyer’s cancellation of only the escrow instructions due to the seller’s nonperformance does not later affect the buyer’s right to pursue specific performance of the purchase agreement to acquire the property. The purchase agreement remains in effect, unless participants in the transaction also cancel it while canceling escrow instructions. [See RPI Form 181]

Further, when a seller wrongfully claims the buyer’s deposit, the buyer may take advantage of a purchaser’s lien. This lien may be judicially foreclosed to collect withheld funds. [CC §§3050; 3375 et seq.]

However, when a seller intends to market a property for sale, it is disastrous for the seller to have the property tied up as part of an ongoing attempt by the buyer to recover funds in a lawsuit.

Here, it is in the best interest of the seller to cancel the underlying purchase agreement and escrow at the same time — when the buyer is most willing to cancel the entire transaction in exchange for the release of their funds. This eliminates any claims the buyer may later make against the seller, the agent or the property which might hinder the seller’s ability to sell.

In a declining real estate market, a seller’s losses include the difference between the agreed-upon price and the lower value of the property at the time of the buyer’s breach. In times of recession, this often exceeds the amount of the buyer’s deposit.

Here, the seller may consider retaining the purchase agreement to recover losses caused by the buyer’s breach.

Further, the amount of the deposit limits the amount the seller can recovery from the buyer. [See RPI Form 150 §10.8]

When a buyer cancels escrow and releases the escrow deposit without also canceling the purchase agreement, the seller may still collect money losses on the buyer’s breach. [CC §1057.3(e)]

This article was originally posted in September 2015, and has been updated.