When Earnest Money Becomes a Lawsuit

When a real estate purchase falls apart, the earnest money often becomes the whole fight. The buyer wants it back, the seller wants to keep it, and the person holding it is stuck in the middle. The amount is usually smaller than the deal that failed, but the dispute follows its own rules, and the person holding the deposit is bound by them as much as the buyer and seller are.

Three questions that usually come first

• Did the buyer have a right to terminate, such as a financing, inspection, or other contingency?
• Was that right exercised properly: on time, in writing, and in the form the contract requires?
• If not, what does the contract say happens to the deposit when a party defaults?

Everything else, including who is angrier and who spent more on inspections, tends to matter less than those three answers.

The contract comes first

The current Tennessee REALTORS® residential Purchase and Sale Agreement (RF401) ties the deposit to specific events, though older or modified versions may differ. A buyer who properly terminates under a contingency, such as the financing contingency, is generally entitled to a refund. If the buyer defaults, the deposit goes to the seller as a credit against the seller's damages, and the seller may still pursue other remedies. The result cuts both ways: the deposit is not automatically the most a buyer can lose, and it is not automatically all a seller can recover.

Commercial contracts are often custom and may treat the deposit differently, sometimes as the seller's sole remedy. Whether a clause like that is enforceable depends on the contract language and the circumstances, so it is worth reading the default section closely rather than assuming.

Contingencies carry their own obligations. In Vonkrosigk v. Rankin (Tenn. Ct. App. 2000), the Court of Appeals affirmed the return of the buyers' earnest money where they could not obtain financing, emphasizing that buyers relying on a financing contingency must show they acted in good faith in trying to obtain it. A contingency is a right with conditions, not an exit that opens automatically.

What the holder can and cannot do

When a principal broker holds the deposit in the firm's escrow account, TREC Rule 1260-02-.09 limits when the broker may release it. The listed grounds are:

• a reasonable interpretation of the contract that authorizes the broker to hold the money;
• a separate written agreement signed by all parties with an interest in the funds;
• closing;
• rejection of an offer, or withdrawal of an offer that has not been accepted;
• filing an interpleader action in a court of competent jurisdiction; or
• an order of a court of competent jurisdiction.

If the contract names someone else to hold the deposit, such as a title company or closing attorney, the rule relieves the principal broker of responsibility once that holder receives the funds. From then on, the broker is out of the picture for those funds, and the contract is the main guide to what the holder may do.

The 21-day clock

TREC's rule includes a deadline that both sides should know about. Absent a compelling reason, earnest money must be disbursed, interpleaded, or turned over to an attorney with instructions to interplead within 21 calendar days after the broker receives a written request for disbursement. Until someone puts that request in writing, the 21-day clock has not started, though the broker's general duty to disburse without unreasonable delay still applies.

Interpleader: letting a court decide

Interpleader, under Tennessee Rule of Civil Procedure 22, lets a holder facing competing claims deposit the money with the court and ask to be discharged from liability for the funds, leaving the buyer and seller to make their cases. Tennessee law also allows interpleader in general sessions court within that court's civil jurisdictional limit (Tenn. Code Ann. § 16-15-731), which can make smaller deposit disputes more manageable. Brokers should know that Tennessee's Attorney General has opined that a non-lawyer broker filing an interpleader on behalf of a firm may be engaged in the unauthorized practice of law, depending on the facts (Op. Tenn. Att'y Gen. 14-08).

Interpleader is not free. The RF401 form allows the holder to be reimbursed for its costs and expenses, including reasonable attorney's fees, out of the interpleaded funds, which shrinks the pot before anyone wins it. A separate release signed by all parties is one of the listed grounds for disbursement, which is why a negotiated split is often the fastest way to release the funds.

A TREC complaint will not return the deposit

The Tennessee Real Estate Commission states that it cannot recover or order the refund of money or property. It can review a licensee's conduct, and failing to account for or remit money belonging to others within a reasonable time is a ground for discipline under Tenn. Code Ann. § 62-13-312. But the deposit itself is recovered, if at all, through the contract, an agreement, or a court. How the regulatory and civil tracks differ is worth understanding before choosing a route.

Who is entitled to a particular deposit depends on the contract language, the dates, and the notices that were actually sent. If you are a buyer, seller, or escrow holder in an earnest money dispute in Middle Tennessee, my office can review the contract and the timeline with you.

Educational disclaimer: This article provides general Tennessee educational information only and is not legal advice for any specific contract, deposit, or dispute.