The earnest money is a well-known piece of legal pop culture, and its most basic features have become part of lay legal knowledge with regard to property sale and purchase contract. It can be seen as a voluntary sanction for breach of contract.
What is an earnest money?
This is the amount of money transferred when the real estate sales contract is concluded. It is used to confirm the commitment to perform the sales contract. Let’s say that it is a voluntary penalty for breach of contract.
Let’s see how this security-like amount behaves during the performance of the contract.
- If the contract for the sale of the property is fulfilled, the amount of the earnest money is normally included in the purchase price of the property.
- If the contract is not fulfilled and the buyer is liable (for example, if he fails to pay the purchase price or any part of the purchase price specified in the contract), he will lose the earnest money given to the seller.
- If, for reasons for which the seller is responsible, the contract is not fulfilled (for example, if the seller does not take possession of the property), the buyer must repay twice the down payment received.
- If the contract is terminated for a reason for which both parties are responsible or for which neither party is responsible – for example, if the property is destroyed in an earthquake, for which neither party is obviously responsible – the earnest money will be returned to the buyer.
Flat-rate function
It serves as liquidated damages. This means that up to the amount of the earnest money, the contracting party does not have to prove the extent of the damage caused by the failure of the contract. It also means that the amount previously paid as compensation must be included in the amount that has been paid to the seller. This is classically the case for late payment penalties already paid by the seller. Thus, in the event of a default, the seller must pay the buyer twice the amount of the earnest money, deducting the amount of the penalty already paid.
The enforcement of the earnest money does not prevent a party from claiming damages in excess of the down payment from the party in breach of contract. If it can be proved that the damage is even greater than the amount of the earnest money. This amount can also be claimed from the other party.
What is is the regular amount of earnest money?
Payment can be made by cash transfer, by bank transfer or, in justified cases, even by depositing with a lawyer. The common misconception that payment can only be made in cash is therefore wrong. The amount is usually 10% of the purchase price, but may be increased or reduced as agreed between the parties. Our law imposes only one restriction on the amount: if it is excessive, either of the contracting parties may apply to the courts for a reduction of the amount of the excess earnest money. There is no predetermined limit as to when the amount is too high, the court will decide in each case by taking into account all the circumstances of the contract. For the sake of simplicity, let us agree that in general we can’t make a big mistake to make earnest money of less than 20% of the purchase price.
Down payment or earnest money?
The difference between the two legal instruments only arises in the event of the failure of the contract. We have already described how the earnest money behaves in such cases. In comparison, the down payment is nothing more than a mere instalment of the purchase price. Accordingly, in the event of the contract failing, the advance payment is returned to the buyer without any hocus-pocus.
The risks for the buyer
As already explained in our article, if the contract is terminated for a reason for which both parties are responsible or for which neither party is responsible, the earnest money will be returned to the buyer. In theory…
In practical terms, however, the buyer is still in a significantly less favourable position than the seller. If the seller defaults, the buyer would get back twice the payed amount. But since only the buyer pays the earnest money at the time of the contract not only does the buyer not have twice the amount, but the seller has the earnest money in his possession.
In a regular sales contract, the amount of a few million forints of the earnest money is such a serious issue for the buyer that by withholding the amount, the seller is in a “blackmail position”. If the buyer wants to get his earnest money back, he is forced to submit to the seller’s will.
Talking about paying twice the earnest money is unrealistic fantasy. Of course, it cannot be ruled out, as total solar eclipses are observed every century as well.
Sample document – 2023
Google search results show that one of the most popular topics is downloading samples for earnest money from the web. We also receive daily enquiries about whether we can send you a good sample for handing over earnest money. We would certainly gain a lot of popularity if we could make such a sample document available for download directly on our website. Why we do not do this, in the face of the popularity we so much desire, has already been explained in the previous paragraph.
There is no perfect sample document that can read the minds of the contracting parties and work out what terms they want to agree to in the property sale contract. It is not possible to draw up a safe sample document, since any terms that are left out of that particular specimen obtained from the internet, compared to the one drawn up by the lawyer, will be at the risk of the buyer acting on the basis of the sample document in the event of the transaction failing.
In such an undesirable case, it will not be clear whether the payed amount will be returned to the buyer or not, due to the numerous missing conditions. And the empirical psychology of the situation shows that in this situation surrounded by uncertainty, the seller (property owner), who has already spent the amount in his mind, will not have the intention to pay it back.
Misconceptions about the earnest money
It is a common misconception that a party who breaches the terms of a contract for the sale of real property can be exempted from its obligations under the contract by waiving the earnest money or repaying the amount twice. I will not go into more theory than this, so I will give a practical example.
- We often hear that the seller says he has found a buyer who will pay more, so he will return twice the earnest money to the buyer and sell the property to the other competitor, even though he cannot do so. The seller has no such choice. If the seller refuses to perform the contract – for example, refuses to take possession of the property despite paying the purchase price – the buyer can choose to withdraw from the contract and claim back twice the down payment or continue to demand the keys to the property.
- Equally wrong is the mindset of a buyer who thinks he will forgo the earnest money and buy another property. It is entirely up to the seller who has suffered a breach of contract to decide whether, in the event of non-payment of the purchase price, to withdraw from the contract of sale and keep the money or to continue to demand payment of the purchase price. A defaulting buyer has no choice but to release himself from the obligation by waiving the earnest money.
The function of this legal instrument is to sanction the wrongful termination of the contract, not to be the consideration for the arbitrary termination of the contract.
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