[Editor’s Note: Although John Beck limits his discussion to the State of California, contract law is fairly uniform among the 50 states, and this is fairly basic contract law.]
I recently came across this question:
I am in a conflict with a seller, and I have no earnest money involved. Does this in itself make my purchase agreement unenforceable in a court of law? Please let all of us know [i.e., real estate investors] the correct answer to this, so we can construct proper [real estate purchase] agreements in the future. Thanks.
The very first section of every standard pre-printed real estate purchase/sale contract form used by real estate agents in the State of California provides that the buyer of real property to make a deposit of money (generally referred to as an “earnest money deposit”), e.g., the California Association of Realtors’ (CAR’s) Real Estate Purchase Contract and Receipt for Deposit (Form DLF014), Professional Publishing’s Standard Residential Purchase Agreement (Form 101.1CAL through 101.5CAL), etc.
For instance the CAR form starts out as follows:
Received from [name of buyer], hereinafter called Buyer, the sum of [some dollar amount] dollars $[some dollar amount] evidenced by ____ cash ____ cashier’s check ____ personal check ____ or ____ [block to be checked], to be held uncashed until acceptance of this offer as deposit on account of purchase price of [some dollar amount] Dollars $[some dollar amount] for the purchase of property, situated [name of city or unincorporated area], County of [name of county], described as follows [street address].
A real estate buyer unsophisticated in the law of contracts could easily read the above language and conclude that he or she must make a “deposit” in order to create a binding purchase/sale contract. Further, this perception of the buyer is typically reinforced whenever he or she makes an offer through a real estate agent.
The agent invariably insists that such a deposit absolutely must be make. Given the drafting of standard real estate purchase/sale contracts and the attitude of the typical real estate agent, it’s easy to see why Gerald would ask if having “no earnest money involved” would make his “purchase agreement unenforceable in a court of law.”
Earnest money is not necessary
The answer is simple: Having “no earnest money involved” does NOT make any real estate “purchase agreement unenforceable in a court of law.”
California law provides that there are four essential elements necessary to found a binding contract: “1. Parties capable of contracting; 2. Their consent; 3. A lawful object; and 4. A sufficient cause or consideration.” Nowhere in this list of essential elements is there a requirement that there by a “deposit.”
However, in order to create a binding real estate contract, both the buyer and the seller must provide “consideration.” As it is often stated, there must be “mutuality of consideration.” What’s “consideration”? California Civil Code Section 1605 defines “consideration” to be the following:
Any benefit conferred, or agreed to be conferred, upon the promisor, by any other person, to which the promisor is not lawfully entitled, or any prejudice suffered, or agreed to be suffered, by such person, other than such as he is at the time of consent lawfully bound to suffer, as an inducement to the promisor, is a good consideration for a promisor.
Different “forms” of consideration
As can be seen by reading the above definition, the “deposit” of money evidenced by “cash,” “cashier’s check” or “personal check” provided for in the above contract language could be considered as a “benefit conferred” by the offeror/buyer to the offeree/seller and a “prejudice suffered” by the offeror/buyer on behalf of the offeree/seller.
By making a “deposit” the offeror/buyer, the offeror/buyer gives the offeree/seller “consideration” upon acceptance of the offer by the seller. Thereby, the buyer has meet the forth essential element necessary to “found” or create a binding contract.
However, is a “deposit” necessary to create a binding real estate purchase/sell contract? The California definition of “consideration” using the language of “any benefit conferred, or agreed to be conferred” and “or any prejudice suffered, or agreed to be suffered.”
Basically, whenever a buyer makes an offer to purchase real property at a certain price and in accordance with certain terms and conditions, upon acceptance, that buyer is providing to the seller a “benefit … agreed to be conferred” by the buyer upon the seller.
The “benefit” is the commitment of the buyer to purchase the seller’s property at the agreed upon price, terms and conditions.
Additionally, whenever a buyer makes an offer to purchase real property at a certain price and in accordance with certain terms and conditions, upon acceptance, that buyer has agreed to “suffer” a “prejudice.”
The “prejudice” is the obligation to purchase the seller’s property at the agreed upon price, terms and conditions.
The contract is enforceable without earnest money
Gerald states: “I have no earnest money involved. Does this in itself make my purchase agreement unenforceable in a court of law?” Clearly, under California law, absolutely not!
If, as we’ve seen, a “deposit” or “earnest money deposit” is not necessary in order to create a binding real estate purchase/sale contract, why do all of the standard pre-printed real estate purchase/sale forms used by real estate agents in California provide for such a deposit?
The “deposit” is a sales tool
Simple, the “deposit” is a sales device – it helps preserve deals. Real estate agents use it to help lock a buyer into the purchase; it’s an effort by real estate agents to overcome what is often referred to in the real estate brokerage business as “buyer’s remorse,” an all too human emotion.
After a buyer who has made a offer which was accepted and, as a result a binding contract was entered, the buyer begins to seriously doubt whether he should have made the offer in the first place. After all, for a buyer of a home to be owner-occupied, entering into a legal commitment to buy is an enormous financial and emotional undertaking, especially for the first time buyer.
Over the years, real estate agents have found that having at substantial chunk of the buyer’s cash in a “deposit” no longer under the sole control of the buyer can be a very effective antidote to the deal-destroying, “buyer’s remorse” decease.
