There’s been some “buzz” lately about buyers of new construction condos who purchased pre-construction now wanting out of the deal with a return of their earnest money. Motivations vary: they are no longer able to get financing (“WHAT? I need a down PAYMENT!? Since when??”); their life situations have changed (baby + one bedroom condo = problem); or they simply don’t want to be under water the moment they close (those 2007 prices are not so attractive now…). Regardless of the motivation, though, the developer’s response is almost always the same: “Go pound sand. The earnest money is mine.”
Luckily for buyers, there are various federal and state laws designed to protect consumers that may give the buyer a right of rescission (and thus the right to a full return of the earnest money). For example, several decades ago the federal government enacted the Interstate Land Sales Full Disclosure Act (known to its afficionados as “ILSA”), 15 USC 1701 et seq. specifically to protect buyers of new construction. Generally speaking (its a complex statute), a developer must register the project with the Dept of Housing and Urban Development (HUD) and provide buyers with a comprehensive set of disclosures. However, the developer is exempt from the registration and disclosure requirements if it contractually obligate itself to complete the building within two years.
For reasons unknown, many of the new condo developments in the area decided to structure the purchase and sale agreements to fall within this “two year” exemption. Unfortunately for the developers, it is more difficult than first appears, and most of the contracts at issue at least arguably fail to qualify for the exemption. Thus, the buyers of those condos arguably have the right, under ILSA, to rescind the contract and receive a full return of their earnest money. (My partner Marc Holmes and I recently prevailed in an action against WA Square on this basis, so in at least one case its no longer “arguable” — the developer failed to comply with the statute and the buyer had a right of rescission.)
All of this raises an interesting question: Is it unethical for a new construction buyer to seek a legal basis for getting out of the contract with a full return of the earnest money? Our very own Ardell has argued that, if a buyer simply changes her mind about the purchase, the buyer should lose her earnest money. Other people have voiced a similar opinion. Is that right? Is it morally wrong for a buyer to seek a return of the earnest money? Does the buyer’s motivation in seeking to get out of the contract even matter?
I think the answer to that question can be determined by flipping it around. New condo developers are large entities typically owned by sophisticated multi-millionaires. What if one of those multi-millionairre owners signed a contract that required her to perform her contractual obligations two years later, and when the date for performance arrived she stood to lose substantial money if she performed? What if the owner just changed her mind for some other reason? In either case, I think its safe to say that the owner would not perform her obligations. Rather, she would hire a lawyer to identify each and every possible basis for avoiding her contractual obligations. The lawyer would then approach the other party to the contract and see if the parties could reach a compromise. Rich people got rich for a reason: they don’t intentionally make a bad business decision, and when faced with a situation that will cause them to lose money, they hire an attorney to negotiate their way out of it. They use the law in every way possible way to protect and advance their interests.
Which is, of course, the purpose of the law. It only works when it is applied to a particular situation. ILSA was designed to protect consumers. Developers should comply with this law. If they don’t, the law gives consumers the right to avoid their contractual obligations. There is nothing immoral or unethical in using the law to protect and advance your interests. It’s what is expected of every citizen, and its certainly what is done by every citizen who can afford legal counsel. If you’ve decided to not buy that condo –for whatever reason — then you should determine whether the law is on your side. It’s what every person should do — and what wealthy people do all the time.
Craig………….sounds like a giant advertisement for legal services from Buyers who made a poor “timing” of an investment. For we all know real estate is ALWAYS an investment.
Just as timing is critical in the capital markets the masses have now learned it is the same in real estate!
Ray — not trying to be a “giant advertisement,” as we’re generally not even taking these cases anymore. I thought it raised an interesting issue.
Interesting. We have certainly seen our share of buyers getting cold feet around Chicago, but who can blame them? Some developers are auctioning off units so some buyers are underwater before they even close. There have been some cases of developers trying to force buyers to close or take earnest money even though the financing they bought under no longer exists.
In some ways, the buyer is just SOL. You signed up for it and now you don’t want it. As a lender, we see this all the time with rate locks. Borrowers want you to lock and then as soon as rates decrease, they demand to get a lower rate yet will raise all kinds of hell if you tried to raise their rate if mortgage rates went up.
Since big developers try to screw buyers over on so many levels, I really don’t feel bad for them though.
Well, the real question is do you ask for your earnest money back:
a) politely and “hope for the best”
b) claim a death in the family and “hope for the best”
c) claim loss of income due to job circumstance and “hope for the best”
d) hire an attorney which could cost you even more and “hope for the best”
e) any combination of the above, and many others, and “hope for the best”
f) realize your loss will be far less by walking, then by closing, and learn from your mistakes
Good Luck…………..I tend to advise clients “C” and get letters from Lenders indicating you cannot close based on current income.
It all comes down to what you signed. There is no more free money and the purses are zipped until further notice.
It does “come down to what [the buyer] signed,” Ray, but only because what the buyer signed must comply with state and federal law. If it does not, the buyer may have a right of rescission. Option (d) is more viable the more money you have to lose. Since new construction requires 5% of the purchase price in earnest money, it is probably worth a little more ($1-2k) to get an attorney’s opinion as to your ability to get it back.
“…the law gives consumers the right to avoid their contractual obligations…”
Not quite, its the lack of performance by the Developer which causes this to occur. Developer completes project within “two year
In fact, Jim, whether the Developer actually completes the building within two years is irrelevant. Rather, the inquiry focuses on whether or not the developer is OBLIGATED to do so at the time of contract formation. Also, even where the obligation is illusory (and thus the Developer does not fall within the exemption), it still requires an affirmative rescission by the buyer — the contract does not automatically terminate. So, the law does give consumers the right to avoid their contractual obligations.
That said, we’re arguing largely over semantics…
Craig, I’m sure you have seen many of these contracts. How is appraisal going to come in at VALUE of purchase price? It is my assumption that most of these Buyers are Pre-Approved subject to financing. When the sales price exceeds the value upon completion the seller MUST lower their price or the bank will not lend them the money to close. Or the Buyer must come up with the difference in CASH.
What the heck are these people signing? I understand if its cash… but thats less then 5% of the real estate transactions are. Where is the problem here? Buyers that want out just because they want out? Or buyers are “locked in” and not subject to financing. Who the heck would put 5% down on anything, on a date down the road, with project delays etc., without escape clauses in/re to financing?
Who would buy any condo…or any real estate…….with a non-refundable earnest money due to inability to secure a loan at a specific sales price?
BTW of course YOU pick option D……………………just kidding….I would seriously like to take a look at what people have signed and who represented them? I cannot imagine they are not subject to fair appraisal value…….
Craig,
To be clear, I recently said that if a buyer wants to try to get their Earnest Money back, when they do not have an obvious legal “out” open to them, they must contact an attorney to do that. They should never ask an agent to try to get the Earnest Money back, unless there is an open “legal out” for them to take.
The last thing I want is for agents to be telling people to lie…about anything. Maybe I’m reading Ray’s comment wrong, but getting a phoney mortgage denial letter and pretending to have lost your job, is NOT something an agent should ever suggest as a means of the return of Earnest Money.
I did receive a call recently from someone seeking to get their Earnest Money returned due to loss of job and inability to finance. She had a letter from her lender. This was a general call from a blog reader, and not a client. During the course of the conversation she told me she was buying a different property (using the same lender). She planned to buy it immediately after getting her money back on her claim for release of the Earnest Money.
So I will caution anyone who is thinking that they are going to lie about not being ABLE to purchase, they should clearly NOT be thinking that they are going to turn around and buy a different property as soon as they get their money back. That would seem obvious to me…but apparently is not. I’ve heard that same story a few times from people.
Under no circumstances should an agent even attempt to help someone get their Earnest Money back who does not have an obvious legal out in the contract. Most times doing that will hurt the client’s chances of getting legal assistance, as the buyer and agent may reveal things while “trying” that will make it more difficult for the attorney to be successful.
Under no circumstances should an agent even attempt to help someone get their Earnest Money back who does not have an obvious legal out in the contract.
I strongly disagree. Every Agent needs to stand by their client AND attempt to get their client’s earnest money back. Your term “obvious” is in error. What is “obvious” to one person is NOT to another nor the courts.
If my Agent assisted me in a contract, that I could not close due to a rapid decrease in value, thereby causing me a loss of MY earnest money………. they better assist me in every way they can. They better call my lender, the builder, the state, the AG, and report it to the news media. I did this very thing in Salem, Oregon with my agent. We even hired guys from labor ready to picket the builder. It took 840.00 in labor but in the end we got our 5000.00 back.
See Ardell when you have no skin in the game its easy to walk away. But, when its YOUR money it makes all the difference.
You assist your client in EVERY way you can. What else were you hired to do? Fill out forms?
Ray,
I strongly disagree. Under no circumstances are you to tell your client to lie and/or call the lender to come up with a bogus mortgage denial.
NO, NOT, NEVER.
That is not within the authority given you by your real estate license.
There is a right and wrong in every contract, depending on the agreements made in that contract.
It is wrong for a seller to try to keep a Buyer’s Earnest Money when they want to cancel for a legal out. If the contract says the buyer has the right to cancel on the home inspection by Friday, and they cancel on Thursday, it would not be right for the seller to try to keep their Earnest Money. It doesn’t matter if my client is the seller and they WANT to keep the money in that situation. The buyer has the right to walk and take their Earnest Money with them.
You and I have every obligation to assist our clients within the contract provisions. Outside of the contract provisions, they need an attorney.
What happens if you help your client lie and say they can’t get a mortgage (C in your example) and then they turn around and buy a different property with you?
I would never hire someone who would lie FOR me to get something FOR me, because that means they would lie TO me to get something for themselves. I won’t work with a seller who wants to lie to a buyer. I won’t work with a buyer who wants to lie to a seller. Anyone who can stand in a room and help someone lie to win…is not trustworty. (In my opinion, of course.)
hmmmmmmmmm…don’t think I ever said lie. Did I infer that from “C”? I would guess “B” would be a lie long before “C”. I think you need to again reread the topic of discussion.
Is it unethical for a new construction buyer to seek a legal basis for getting out of the contract with a full return of the earnest money?
My answer is absolutely not…………If my Buyer changes his/her mind I will personally seek to retrieve their earnest money back FOR ANY REASON. If I’m unsuccessful in arbitration then I will advise the client that I have done everything within my power. I was hired by my client to represent them, not push a transaction to close.
Life happens and although I may not agree with WHY my client wants out, I was still hired by them. My obligation is and always will be to my client. I think you are quite misdirected and again illustrating why real estate (the way it is practiced) is fundamentally flawed.
When the golden carrot is achieved by closing a transaction, interests of the agents always trump that of their clients.
Ray,
Your answer was: “Good Luck…………..I tend to advise clients “C
This is a horrid comparison but its what popped in my head.
Johnnie Cochran was hired by OJ Simpson. Johnnie Cochran served his client until the end which was the conclusion of trial. I assume he did not condone the acts that were committed by his client but none-the-less he fulfilled his duty.
I turn down many clients and also accept many. When I enter into a Buyers Agency agreement I agree to serve my client and place their needs above all others. This is how I do business and I also choose to terminate my Buyer Agency agreements.
The earnest money is my clients committment to purchase. If “life circumstances” occur I fight for my clients earnest money refund to the best of my ability. I offer my opinion when warranted but still serve my clients needs until close of transaction or termination of agreement by either party.
If fraud or deceipt is detected by myself I immediately terminate the agreement as you would. We just differ in our opinions of practice.
Neither of us has likely ever had a client lose their Earnest Money, so it’s probably a moot point 🙂 Have a good night Ray.
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Earnest money in many cases is going to be less then hiring an attorney to try and get the earnest money back. Even so let’s say the condos in question is $300,000 and the earnest money is 1% or $3000. The project is completed 12 – 18 months later and property prices have declined 16% from when you negotiated the price on the condo. Assuming that the developer hasn’t created some obviously loopholes for the buyer to walk through it may simply be cheaper to walk away from the earnest money then to attempt through legal means to get it back. In even the most basic of actions you are going to spend hundreds of dollars (close to $1000) and if its protracted with letters and accusations going back and forth well the money and the time you spend on this will only provide financial benefit to those who are arguing your position.
Why not treat the earnest money more like an option at least from the buyer’s perspective. You’ve made and offer, its accepted and lets treat your $3000 as an option to purchase rather then an obligation to purchase. A lot can happen between now and when the project is completed however you have tied up a unit for $3000 and if it turns out its the right decision for you then then lets complete. If not then walk away. In all likelihood if the market continues the way it has in the last couple of years you’ll be able to walk away and turn around and buy it for a lower price anyway.
Glenn — you are absolutely correct. When deciding whether to spend money seeking the recovery of earnest money, the very first consideration is the amount of earnest money at issue. In your hypothetical, a buyer would be making a bad decision indeed in hiring an attorney to chase $3k. Attorney’s fees will quickly surpass that amount so the buyer loses even if he wins.
However, your hypothetical is seriously off the mark in regards to new construction. Specifically, EVERY developer requires 5% of the purchase price in earnest money, not just 1%. Moreover, the majority of the new construction condos are “high end” and thus usually cost more than $300k. Of the perhaps 30 people with whom I have spoken who want out of the contract, only two or three had earnest money deposits less than $20k.
So, in reality, buyers must decide whether to fight over a sum usually in excess of $20k. If you can find an attorney to take the matter on a contingency basis, it makes sense to invest some funds in an effort to get some or all of the money back.
Dont for get its not always all or nothing with EM one or both sides can offer a split and walk of the EM