If a buyer back out of a real estate contract without a valid reason, then the seller can keep the deposit. A buyer backs out of a real estate contract to purchase a home or property for two reasons, either due to contingencies or non-contingencies. A buyer can back out of contract due to contingencies that are written in the contract, such as financing contingency, home inspection contingency, appraisal contingency, home sale contingency, and clouds on title. A buyer can also back out of the contract due to non-contingencies, such as withdrawing the offer prior to its acceptance by the seller or for any other reason outside of the contingency, such as job loss, finding another dream house, or a financial crisis. The consequences of backing out of the contract would depend on the buyer’s reasons.
The buyer backing out due to a contingency – seller has to return the deposit
When a buyer backs out due to a contingency and he follows the procedure stated in cancelling the contract, the buyer is entitled to a return of his earnest money deposit. An earnest money deposit is a downpayment made by the buyer to the seller, generally between 1% to 5% of the total contract price, deductible from the total amount due upon closing. In some states like New York, the earnest money serves as liquidated damages in case the buyer defaults and does not close based on any valid reason under the real estate contract and to compensate the seller for not offering the property during such period between the acceptance of the offer and closing.
Regular contingency clauses that can be found in real estate contracts are financing contingency, home inspection contingency, appraisal contingency, home sale contingency, and clouds on title. However, just because these are regular contingency clauses does not mean that your particular contract includes them. In Abart Holdings LLC v. Bayou Properties, Index No. 600258/2009, the Court denied the purchaser’s request to return the earnest money deposit, even if purchaser was not able to secure financing, because the real estate contract did not provide for a financing contingency. The Court will not provide for a condition precedent to closing, such as a financing contingency, if such condition precedent is not stated in the contract. For this reason, buyers should always seek the advice and services of a lawyer before signing any real estate contracts, especially since these contracts involve a lot of money and can represent the entire savings of a home purchaser.
A financing contingency allows a buyer to validly back out of the contract, in case his lender does not approve his mortgage. A home inspection contingency allows the buyer to cancel the contract in case the house does not pass inspection and requires necessary repairs. Sometimes, the results of the inspection are used by the buyer to request for a discount of the total contract price or to request the seller to make the necessary repairs. If the seller refuses, the buyer can walk away under a home inspection contingency. An appraisal contingency allows the buyer to cancel the contract if the appraised value made by a certified independent-third party appraiser is substantially lower than the total contract price and the seller refuses to lower his asking price. A home sale contingency allows the buyer to back out of the contract when the sale of his own home does not push through within the time period required. A buyer can also cancel the contract when the title insurance company finds clouds on the title (such as liens, etc.) and these clouds are not corrected or removed prior to closing.
As mentioned, some contracts will not contain any of these contingencies, while other contracts will contain some, but not all of these contingencies. Some contracts will contain other types of contingencies. It’s best to read the contract to see if it contains any contingencies or provisions that allow a buyer to back out of the contract.
When backing out, it is important for the buyer to strictly observe the procedure and time periods stated in the contract. Failure to follow the procedure or raising the contingency beyond the time period provided will result to an invalid cancellation of the contract and the seller’s entitlement to the earnest money deposit. In the case of Maxton Builders v. Galbo, 68 N.Y.2d 373 (1986), the Court denied the buyer’s request for the return of the earnest money deposit, even when the buyer exercised his right to cancel based on the contract clause, stating “if real estate taxes are are in excess of $3,500 based on a full assessment of house sold for $210,000.00, buyer shall have the right to cancel this contract upon written notice to the seller within three days of date and escrow funds to be returned” because the buyer exercised his right beyond the 3-day period provided. For this reason, it is important to read and re-read the contract when faced with a buyer wanting to back out of the contract to ensure that the procedures and timelines are strictly observed.
It is also important that the reason for backing out of the contract is supported by sufficient evidence. In Cetindogan v. Schuyler, 2011 N.Y. Slip Op. 30871 (N.Y. Sup. Ct. 2011), the Court directed the return of the earnest money deposit to the buyer, a Turkish citizen who was not able to purchase the Manhattan apartment because the co-op board rejected his application. The seller wanted to retain the $300,000 deposit, claiming that the buyer self-sabotaged the interview. However, the seller was not able to provide proof of self-sabotage aside from hearsay evidence coming from an alleged unnamed board member who claims that the buyer deliberately provided answers she knew would result in the rejection of her application by the board. Thus, in any case arising out of the return of earnest money deposit, it is always better to be supported by sufficient evidence in one’s cause of action.
A buyer backing out due to non-contingencies: seller does not have to return the deposit
A buyer can back out due to non-contingencies, but this is normally considered as default, and will result to the forfeiture of the earnest money deposit. However, when the buyer back outs and formally withdraws his offer before his written offer is accepted in writing by the seller, there will be no forfeiture of the earnest money deposit, because in this case, there is no perfection of the real estate contract. A contract is perfected upon the meeting of the minds of both the buyer and seller, and when an offer is withdrawn before it is accepted, there is no perfection. Thus, there is no consequence in backing out in this case.
On the other hand, when the contract has already been perfected, the buyer can only back out based on the contingencies provided in the contract. If the buyers back out outside of these contingencies, he is considered in default, even if such reason for backing out is valid, such as the loss of a job, an economic crisis, or a pandemic. In Donerail Corp. v. 405 Park LLC, 100 A.D.3d 131 (2012), the Court allowed the seller to retain the deposit, despite the fact that there was a sharp decline in the market value of office buildings in Manhattan during the 2009 financial crisis. In the landmark case of Lawrence v Miller, 86 N.Y. 131 (1981), the court allowed the seller to retain the earnest money deposit because the buyer defaulted without valid reason and the seller was willing and able to perform his obligations under the contract.
In any dispute involving real estate contracts, it is important to remember that the contract is the law between the parties and its provisions should be strictly observed. If you are a seller and the buyer is demanding that you return the deposit, we at the Law Offices of Albert Goodwin, are here for you. You can call us at 718-509-9774 or email at attorneyalbertgoodwin@gmail.com.
