What You Should Know about Small Claims Disputes over Down Payments

It’s not uncommon for a person to put a down payment on a house, then have the deal fall through, landing you in small claims court. If the seller is the one who calls off the deal, she usually authorizes the return of the deposit to the would-be buyer.

Because she changed her mind, she can’t keep the money. The buyer may have a separate lawsuit for damages for the expenses incurred as a result of the seller changing her mind, but that has nothing to do with the return of the down payment.

When the buyer is the one who changes her mind due to buyer’s remorse, or a bad home inspection, or some other reason, she still usually wants the down payment refunded. Cases end up in small claims court when the seller refuses to give it back.

The buyer has to sue the seller to compel her to give back the money if she has it, or for her to authorize the escrow agent to return the money if it was put into an escrow account.

Using an escrow agent — a third party other than the seller or the buyer to hold the down payment money — is a good practice. An escrow agent is a fiduciary — a person with certain legal obligations and restriction on her actions who can’t act unless the parties agree or she’s ordered to do so by a court.

The escrow agent can’t unilaterally decide who gets the money. The escrow agent may be a lawyer, a title company, an escrow company, or a real estate broker, depending on the practice in your state.

Even though the escrow agent is not the person preventing the release of the money, if you’re suing for return of a down payment, you have to name the agent as a defendant stakeholder — a person holding money for the benefit of others without an ownership interest in the money — so that she will be bound by the court order directing the release of the money.

Don’t be surprised if the escrow agent as the stakeholder brings a lawsuit saying “Hey judge, I have these two guys who can’t agree what I should do with the paltry sum of money I’m holding. Judge, please tell me what to do or let me pay it into the court so I can get on with my life.”

This stakeholder action is designed to relieve the stakeholder of responsibility for the money. This may or may not be brought in small claims court. In all likelihood, you’ll be named as a defendant. This lawsuit will result in an order telling the stakeholder whom to pay, so it may save you the cost of bringing your own lawsuit over the issue.

In order to keep the money, the seller has to establish that she was ready, willing, and able to perform the contract and sell the property. If the seller can’t do so, then she can’t keep the deposit. In order for the buyer to get the money back, she has to establish either:

  • That the seller is in default of her contractual obligations and can’t or won’t sell the house.

  • That the buyer was ready, willing, and able to close, or if she isn’t able to close, it’s not her fault. If you’re the would-be buyer, you have to have a valid reason for not living up to the terms of the contract. You need to cite some unforeseen event that makes it impossible for you to fulfill the terms of the contract.

A couple of examples show a faulty reason and a low-fault one:

  • A buyer has 60 days to get a mortgage commitment from a bank. She decided she doesn’t want the house and waits until day 59 to apply. On day 61 she asks for her money back because she didn’t get a mortgage commitment. The buyer would certainly have a hard time claiming she deserves her money back in this situation.

  • The buyer has 60 days to get a mortgage commitment from a bank, applies on day 1 and by day 10 has a commitment subject to providing proof of employment and sufficient income until closing of title. On day 50, the buyer finds out that she has been laid off because her employer, MouseMobileMotors, a company that designs cars has been shut down.

    This is a situation beyond the buyer’s control, and in all likelihood, she would be able to recover her deposit. The would-be buyer has a legal obligation to notify the lender of her employment status. The failure to notify the lender may be considered fraud against the lender.

If you’re the buyer, before you bring a suit to get your down payment returned, make sure you read the contract to see whether you complied with all of the terms of the agreement, especially any terms requiring that you give notice to the other side of your desire to cancel the contract and recover the deposit.

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