Multiple Choice Question: You are the listing agent. A buyer submits an offer on a C.A.R. Residential Purchase Agreement (RPA). The offer says “zero” for both an initial earnest money deposit (EMD) and increased deposit. What is the legal meaning of a purchase agreement with no EMD? Pick the best answer:

A. It means that there is no consideration, and so the contract is invalid.
B. It means that, if the liquidated damages clause is initialed, and the buyer later defaults on the contract, the seller has to go after the buyer for 3% of the purchase price as liquidated damages.
C. It means that the seller may have less leverage over the buyer, as compared to a transaction with an EMD.
D. All of the above. 

Answer: Answer A is wrong (and so Answer D is wrong too). Answer A is a common misconception among agents. An EMD is not consideration. Let’s say, for example, that a seller enters into a valid contract to sell a house for $1 million. The consideration for the house is the $1 million purchase price, not the EMD. The law does not require any EMD for the parties to enter into a valid contract.

Answer B is wrong. If the liquidated damages clause is initialed, the parties agree that the liquidated damages will be “the deposit actually paid” (see paragraph 26 of the RPA). Since the EMD in our situation is zero, the liquidated damages are also zero. It’s true that when the EMD is more than 3% of the purchase price, the liquidated damages are capped at 3% for a one-to-four residential unit property that the buyer intends to occupy. But if the “deposit actually paid” is zero, the seller’s liquidated damages are also zero.

Answer C is the correct answer! An EMD can give a seller some leverage over the buyer. With an EMD, the seller has a certain level of assurance that the buyer is serious about buying the property. Once the buyer’s EMD goes into escrow, the buyer usually cannot get the money back without the seller’s written consent (or a court order). Also, if the buyer removes all the buyer’s contingencies, but then defaults, the seller is generally entitled to keep the EMD (usually up to 3%) as liquidated damages. Additionally, if the seller ever wants to do a mutual cancellation of escrow, it’s much easier for the seller to accomplish that when there is an EMD in escrow that the seller can decide to return wholly or partially to the buyer, as compared to another escrow with no EMD.

An EMD is not a legal mandate. However, in our real estate practice, we have come to realize after many decades of experience that EMDs help ensure that buyers are serious about purchasing a property, and that the transaction will close escrow successfully.

-Thank You to Buki Burke (Ventura Office) for suggesting this week’s legal tip!

Copyright© 2024 Berkshire Hathaway HomeServices California Properties (BHHSCP). All rights reserved. Any unauthorized reproduction or use of this material is strictly prohibited. This information is believed to be accurate as of September 16, 2024. It is not intended as a substitute for legal advice in individual situations, and is not intended to nor does it create a standard of care for real estate professionals. Written by Stella Ling, Esq.