By our Legal & Ethics Counsel
Upshot: In earnest-money disputes, there are several options rooted in the Brokers’ Act and TREC rules that you might explore to help your clients resolve the issue.
When a contract falls through, the effects can include earnest-money disputes. For example, an agent might think the buyer and seller have agreed to split the earnest money; however, the seller may then claim the entire amount. If this or something similar happens, what can you do to help resolve the dispute?
Tennessee law and rules address the duties of a real estate professional when it comes to earnest money. The holder of the funds can make a reasonable interpretation of the contract or interplead the funds as outlined below.
A principal broker is required under the Broker’s Act to distribute the funds in your escrow account “within a reasonable time.” Tenn. Code Ann. § 62-13-312(b)(5) The Tennessee Real Estate Commission (TREC) defines “reasonable time” in TREC Rule 1260-2-.09(7): “Funds in escrow or trustee accounts shall be disbursed in a proper manner without unreasonable delay. Funds should be disbursed or interplead within twenty-one (21) calendar days from the date of receipt of a written request for disbursement of earnest money.”’
The principal broker holding the funds has several options available to remit the funds if a deal does not close. Who is entitled to the earnest money will vary case by case. If a client has questions about whether he is entitled to the earnest money and/or whether he can back out of a contract, he should speak with his own attorney.
TREC Rule 1260-2-.09(6) outlines how a broker may distribute earnest money: “A broker may properly disburse funds from an escrow or trustee account: (a) upon a reasonable interpretation of the contract which authorizes him to hold such funds; (b) upon securing a written agreement which is signed by all parties having an interest in such funds, and is separate from the contract which authorizes him to hold such funds; (c) at the closing of the transaction; (d) upon the rejection of an offer to purchase, sell, rent, lease, exchange, or option real estate; (e) upon the withdrawal of an offer not yet accepted to purchase, sell, rent, lease, exchange, or option real estate; (f) upon an interpleader action in a court of competent jurisdiction; or (g) upon the order of a court of competent jurisdiction.” Just bear in mind that according to TREC Rule 1260-2-.09(7) that this should be done within 21 days from the date it is first requested in writing.
If you have a valid contract, then you will likely only have four options available. The holder of the earnest money can choose whichever option they wish.
1) You can try to get the parties to agree on the distribution. You may use Tennessee REALTORS® form RF 481, the Earnest Money Disbursement and Release Form, for this purpose. This option requires the signature of BOTH the buyer and the seller. The form states that both sides are giving up their right to sue on the contract. If the parties want to reserve the right to file a lawsuit, it would be wise to have an attorney assist you in drafting an agreement for the release of the funds.
2) If you cannot get an agreement by the parties, you, as the holder of the funds, will need to review the contract to determine if you can make a reasonable interpretation. The party who does not receive the funds could file suit against you and the party receiving the funds. However, there is language in the PSA which will give you some protection. The PSA states, “No party shall seek damages from Holder (nor shall Holder be liable for the same) for any matter arising out of or related to the performance of Holder’s duties under this Earnest Money paragraph.”
3) If not, then you can interplead the funds.
4) The final option is a court order (this is seldom used).
An interpleader is a safer option than making an interpretation of the contract, as the judge will determine who receives the funds. If you make a reasonable interpretation, there is the possibility that the party not receiving the funds could sue you.
If you decide to interplead the funds, here is some insight on how the process works: An interpleader is the court action that the holders of earnest money can take to determine who is entitled to the funds in the event of a dispute between the buyer and seller. If you have to interplead the funds, you will need to file a Petition to Interplead Funds in the General Sessions Court of the County where the property is located. You may obtain a copy of the petition by logging in to www.tnrealtors.com and downloading and/or printing Form RF 481. Typically, once the petition is filed, copies will be served on the parties to the contract and a hearing date will be set. On the hearing date, you will appear before the judge and explain why the brokerage is seeking to interplead funds with the court. After (if) the petition is granted, the judge will determine, either that day or at a later hearing, which party (i.e. buyer or seller) is entitled to the funds. The parties will have the opportunity to present their arguments to the judge during that hearing.
The holder of the funds determines whether to file an interpleader. The buyer or seller can request that one be filed, but it is up to the holder of the funds to make the decision. The procedure for interpleader actions differs from county to county and from general sessions court to chancery court. An interpleader action should be filed in general sessions court if the amount of earnest money is less than $25,000. If the amount is $25,000 or greater, the action should be filed in either circuit or chancery court.
If you interplead the funds, the buyer and seller will be named as defendants on the interpleader form. This sometimes upsets the parties to think that they are being sued. However, you should keep in mind that you are not suing them—you are simply turning the funds over to the court and asking the court to decide who is entitled to the funds.
The party responsible for court costs in an interpleader will depend on what the earnest money agreement and/or contract states. Typically, the losing party is responsible for paying court costs.
The firm will be the party listed as the plaintiff. Please note that if the firm is incorporated, an LLC, or certain types of partnerships, they must be represented by an attorney. An individual cannot represent the interests of an incorporated entity without a law license.
You can indicate to the parties that if they cannot reach a decision and/or split, that you will interplead the funds, which will involve court costs and attorney fees that you will seek under the terms of the contract. This may encourage them to reach an agreement.
You should also include a specific request for attorney’s fees and costs.
*It is very important to keep in mind that the options above only apply to real estate licensees. This means if a title company or closing attorney is holding the funds, they are not obligated to disburse or interplead the funds within 21 days. This can be upsetting to buyers or sellers who become involved in an earnest-money dispute. If the parties agree for a third party, other than the real estate licensee, to hold the funds, you should make them aware of this. One option available to firms that prefer closing companies to hold the funds is to have their attorney draft an agreement, signed by the closing company, that reiterates the TREC rules concerning earnest-money disbursal.