Law Office of James Kaklamanos

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Is It Okay to Release the Earnest Money
before Close of Escrow?

It is usually necessary to put up an earnest money deposit when buying real estate. An independent escrow agent normally holds the deposit, although sometimes the broker or an attorney holds it for one of the parties.

The earnest money deposit serves two purposes: (1) it shows that the buyer is serious, and (2) it can be forfeited to the seller if the buyer fails to perform. An independent escrow agent usually holds the deposit, so that it can be automatically paid over to the seller if the buyer defaults, or applied against the purchase price if the sale closes.

In a hot market, the seller will sometimes ask to have the earnest money deposit released to him after the contingencies have been satisfied. The seller likes this because it means he will not have any trouble gaining possession of the deposit if the buyer defaults.

If the buyer objects to this idea, the seller may offer to put a signed deed in escrow, pointing out that he has then done everything necessary to close. He will say that the only thing left to be done is for the buyer to come up with the rest of the money.

This sounds reasonable. What could go wrong?

The answer is "plenty."

In most commercial real estate transactions, the seller has to do more than put a deed in escrow. If the seller is a corporation, trust, or limited liability company, copies of organizational documents may have to be produced and be certified as effective and complete. Resolutions, certificates of good standing, and other items may be required. If, for some reason, the seller cannot produce the necessary items, the closing may be delayed.

In addition, surprises can and do occur. Perhaps a tax lien or mechanics’ and materialmen’s lien attaches to the property just prior to closing. Perhaps an amendment to the title commitment discloses an unknown title defect. Maybe a lawsuit is filed affecting the property, or maybe the seller dies prior to the closing. It is also possible that the property could be damaged or destroyed prior to close of escrow. If any of these things occur, a closing might be delayed or become impossible through no fault of the buyer.

If his earnest money has already been released, the buyer is left in a difficult situation. He must then rely on the seller to give it back (if he has not yet spent it), which could require litigation. At the very least, he has severely weakened his bargaining position and placed himself at risk.

It is a bad idea to allow earnest money to be released prior to the closing. Avoid it if you can. If the seller will not budge and you feel that you definitely want to purchase the property, negotiate the amount down to the smallest amount possible, and make it clear that the seller has to return the money if the closing does not occur for any reason other than your own failure to perform.

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