Legal Breakdown: Earnest Money

IAR Legal Counsel Gabe Walsh and Attorney and IAR Instructor Jorge Gomez, Jr. are back with another Legal Breakdown video to discuss earnest money!  If you prefer to read, you can Scroll below to read the transcript of this video. 

*This video is intended to be an educational resource for Iowa REALTORS®. The information in this video discusses general legal information and is not legal advice or a substitute. Every situation involving areas of law such as this are sensitive to the particular facts of your case, and therefore, you should always consult your own legal counsel to get legal advice.*

I have to admit today's topic is probably one of the most common questions on the hotline. It's a typical situation. It's where something in a transaction goes bad. It doesn't close. All of a sudden the million dollar question is: who gets the earnest money? And that's what we're going to talk about today.

Great topic. And I get that question a lot. Who gets the earnest money? Realtors who are watching this listen, because there's several things you need to consider in determining who gets it, when to release the earnest money, who to release it to, what conditions have to be met before that earnest money can be released.

Absolutely. Most of the time on large ticket items, the purchase agreement sometimes clearly lays out in certain situations who should be refunded in certain situations, but it's not always so clear.

Exactly. That's why the contract language is so important. We talk about certain indefinite terms of purchase agreements. Here's another example where certain indefinite terms are vital, and you need those to protect you as the realtor. As the agents involved. But a couple of things I want to bring up here, Gabe, while we're talking about earnest money and deciding when to return it is this. There's going to be a fine line at some point where deciding on what to do with your earnest money, or deciding who to refund it to, or the timing of it may be considered the unauthorized practice of law.

It's very important that realtors, if you have any questions about that, ask for counsel to assist you ... give you an opinion as to that, number one. Because we have Article 13, which is the unauthorized practice of law. That and then the specific language of the contract, I think, are key elements that we have to keep in mind whenever we have earnest money questions.

Absolutely. It's just so important to make sure you're telling your clients if they're upset there might be a 1,000, there might be 5,000, there might be more earnest money on the table. You don't want to be given any clear legal opinions or anything like that on these issues. You want to make sure your clients, if they feel they're entitled to earnest money ... it's in dispute. Contact a private lawyer of their choosing to look at the contract to have their questions answered about what grounds they may have or may not have for return of earnest money.

Exactly. This is an issue where I can see a lot of [inaudible 00:02:16] the necessity for client control. That client's going to be pushing you as the realtor to either give them the earnest money, or not give the other part of the earnest money. One way or another, you're going to be pushed to make that decision. That's where you might consider getting some help.

Absolutely, George. I think what we're going to talk about now is another aspect of this. Again, who specifically is entitled to earnest money based on the language of a contract's legal question. Get a legal opinion.

But also keep in mind that when there is a dispute in earnest money, there are provisions in license law that tell you as a real estate broker what you can do with earnest money when there's a dispute. We're going to talk about those terms here in just a little bit.
Let me start with that.

I don't like to read in these things. I like to have conversations with everybody.
But this is one where I think we have to be fairly specific on, so I'm going to take some time to read this.

The first thing I want to tell the viewers out there is you want to look at Iowa administrative code 193E. Chapter 13 in particular. You can Google it online. Iowa administrative code 193E Chapter 13, and also your Iowa code 543B. Okay. Look at those. They really address a lot of the earnest money questions you may have, but let me read part of Iowa administrative code 193E, Chapter 13. I'll read it.

"Funds including interest on trust funds shall only be dispersed from the trust account as provided in Iowa code section 543B. And by the terms and conditions of the contract or escrow agreement, no funds shall be dispersed from the trust account prior to the closing or other, or other than as provided by the terms of the escrow agreement without the informed written consent of the parties. In the event of a dispute ..." Here's key. "In the event of a dispute over the return or forfeiture of the earnest money deposit or the disbursement of an escrow deposit held by a broker, the broker shall continue to hold the deposit in the trust account until certain things are met. One of the following is met."

And I'll go through these very quickly: "A, the broker is in receipt of a written release from all parties to the transaction. The broker is in receipt of a final judgment of the court directing the disposition of the deposit or escrow. There is a final decision of a binding alternative dispute resolution. Mediation, if you will. Or a civil court action is filed by one or more of the parties to determine the disposition, or of the deposit or escrow funds, at which time the broker may seek the court authorization to pay the deposit or escrow funds into the court."

There's a lot of provisions. Again, I think we read it here, but it's important because you need to go back through this and read this closely if you're ever in this situation. It lays out very clearly what you have to do. But basically if the transaction doesn't close and there's a dispute, you either have to have one of two things. You have to have a written consent of all the parties to release it. If you don't have that and there's a dispute, you got to wait until one of these four things happen to release it. Otherwise, the default is you continue to hold it.

That's exactly right. That's exactly right.

Now, there is a provision right after that that talks about what you can do as a broker, and what sorts of actions you may take under the commission rules.

These require some notice requirements. Aren't there, Gabe?
There are some notice requirements.

13.1 goes on to say that, "No funds shall be dispersed from the trust account prior to the closing, again, without the informed written consent of all the parties to the transaction." Except in accordance with this rule I'm reading right now. Again, this rule says, "Nothing requires you as a broker to remove the money from your trust account with a disposition of such money is disputed, but the commission will not take disciplinary action against you as a licensee, against a broker. Who in good faith disperses trust account monies pursuant to this rule." And there's two parts here.

The rule says, "That in the absence of a pending civil court action or written agreement, it shall not be grounds for disciplinary action when upon passage of 30 days from the date of the dispute a broker disperses the earnest money deposit ..." key here, "to a buyer. 30 days from the dispute for a buyer, renter, or lessee based on a good faith decision that a contingency has not been met. But disbursement shall be made only after the broker has given 30 days written notice by certified mail to all parties concerned at their last known address setting forth the broker's proposed action for the grounds for the decision."

Now, when we go to the next part of that rule, that lays out the exact same process that must be followed. But when it comes to making a decision to give that money back to a seller, you're going to have to wait six months. And then you're going to have to give those same 30 days notice requirements. Again, if you're refunding to a buyer, 30 days. If refunding to a seller, six months.

It brings up a couple of questions or a couple of thoughts I have, Gabe. And I want you to comment on this. Number one, that's a lot of information.

Realtors, brokers, I suggest you pull up these code sections and read them yourself. Number one. Number two is if you find yourself in these predicaments ... and you will. It's just part of the profession. Part of the business. Do not hesitate to ask for help and counsel. Just don't hesitate to ask for help for counsel.

Because what I would hate to see is for the realtor to in good faith try to do the right thing, but not follow the protocol as dictated in the code, and then find themselves in a disciplinary dispute.

Exactly. Make sure to go back, reread this code. Again, as George said, seek the advice of counsel. Don't be too proud to do that. These are some complicated provisions, but it's important to follow these obligations closely.

Gabe, I have one other question for you. Can a realtor use that earnest money to pay their commission if the deal went south? Could they use that earnest money? If they feel that they've earned the commission, can they use that earnest money 

Yes. That's a great question. And what 13.19 says is no, you can not do that. It says, "under no circumstances is the broker entitled to withhold any portion of the earnest money when a transaction fails to consummate even if a commission is earned. The earnest money must be disposed of as provided in the other rules that we just explained, and the must pursue any claim for commission or compensation against the broker's client." So, very important information to keep in mind.
No earnest money. Earnest money cannot be applied towards commission.
The broker would have to take other means to collect that earnest money, or that commission they felt they heard.

Absolutely. One other thing the rule talks about is situations where clients have submitted a earnest money dispute to some kind of a lawsuit, or have filed some sort of court action. There's then a interpleader provision, right? Which allows a broker to deposit that money with the court.
Right. That's one provision, which I don't think realtors or brokers are necessarily aware of. It's one that I have advised my broker realtor clients about or have them looked at that, because that's the way which they would get that money out of their account deposited in another account until that dispute is resolved.

We know as realtors that dealing with money disputes and dealing with clients funds, you have to be extremely careful. You have to keep these commission rules clearly in your mind. You have to keep your ethical obligations in mind. But again, if you're in these situations, go back to this part of the administrative rules, and review this video, and understand generally what your obligations are and what options you have.

I think that's good advice.

I think that pretty much wraps it up. 
Yes. Do the right thing.



Iowa Association of REALTORS

This article was written as a collaboration of IAR Staff members or invited subject matter experts.

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