Buying or selling a home is a tense, emotionally draining experience, even if things go well. But if the deal falls apart, the experience can be excruciatingly painful and very expensive.
Buyers and sellers both wind up angry, and often the anger is directed at the escrow company, the third party that acts as the neutral intermediary between the two. That's because the escrow company has control of the funds deposited by the buyer, and both buyer and seller may think the money is rightfully theirs, especially if each thinks the other is to blame for the wrangle.
A home purchase may fall apart for any number of common reasons. Usually, the sale is conditioned upon certain contingencies that just don't occur. The buyer may not be able to obtain financing. The home may be infested with termites. A geological or structural inspection may find hidden defects. The seller may just get cold feet and change his mind.
Whatever the reason, for the buyer to get the deposit back, the escrow company will usually require written instructions signed by both buyer and seller canceling the escrow and stating how the deposit will be refunded. Even if it is very obvious to you, whether you're a buyer or seller, that the other person is completely at fault, the escrow company will not refund the money unless both parties agree in writing.
The escrow company is a neutral stake holder. "They are not supposed to interpret, extrapolate . . . or prophesize," observes Doug Ring, a Century City real estate lawyer. "If they return money without having properly documented the (approvals from both sides), the escrow company can be held liable by the party who did not give them the instructions."
When both sides can't agree to written cancellation instructions, the money will be held by the escrow company until a court determines who should rightfully receive it, or the parties settle the dispute. The escrow company can file something called an interpleader action, in which it goes to court and says essentially, "Hey, I have this money, please tell me who I should give it to."
The escrow agreement usually provides that the escrow company will be reimbursed for its legal fees, which means that the deposit will be used to pay the escrow company's attorneys. Even without such an agreement, the judge has discretion to award attorney's fees and usually does, according to real estate lawyer Barry Mitidiere. Because the deposit is commonly under $10,000, there may be little or nothing left once the fees are paid. Instead of losing the deposit to the seller, it goes to the lawyers representing the escrow company. In any event, the buyer isn't happy.
Knowing that this is how such disputes often end, it is wise to forget about the legal solution and try to work out a settlement with the parties, with the help of the real estate agents, especially if the deposit is not large.
There is a better way to help prevent your money from being frozen in an escrow account--a properly drafted purchase and sale agreement. The contract should contain what Ring calls a "self-destruct" provision, which states that "if the contingencies have not been met by a specific date, then the escrow holder is hereby instructed to terminate the escrow and return the deposit less actual escrow fees and costs." Then, in effect, the cancellation instructions have been signed in advance and become effective if the specified date arrives and the escrow hasn't closed.
According to Ring, such a provision is not commonly found in the preprinted form residential purchase agreements usually provided by the real estate brokerage company or the escrow company. (Of course, it is not in a real estate agent's best interest to make it too easy for the parties to get out of the deal. On the other hand, a good real estate agent can often save a sale that is about to fall apart.) It may be worthwhile to discuss with your real estate agent or lawyer whether one should be added to the form you use when you buy or sell a house.
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However, even such a provision does not guarantee protection, because the escrow company will freeze the deposit and won't distribute the funds if one party advises in writing that a dispute exists, Ring adds.
Incidently, if you are depositing a large sum of money for a long time, you should consider requesting that the escrow company deposit the funds in an interest-bearing account for your benefit.
If you want to know more about the escrow process or selling a home, here are two good resource books: "For Sale by Owner" by George Devine and "All About Escrow" by Sandy Gadow.