In an ideal world, every transaction closes without a hitch. However, it’s important to prepare for those times when the sale does not close. In those cases, we are left with the question of how to deal with funds held in escrow.
Closing procedures vary by state. You need to be familiar with the process, whether you do business in an escrow or non-escrow state. The majority of states are non-escrow; in those states, the parties typically sign a purchase agreement and schedule a closing date. On closing day, the parties exchange all necessary documents and funds. In escrow states, like California and Arizona, the parties sign a purchase agreement (or escrow instructions), along with all pertinent documents; these documents are held in escrow until the date of closing.
Despite the differences, there are general principles involving default that apply nearly everywhere.
First, it’s important to confirm that your contract for the sale and purchase contains provisions regarding the duties of an escrow agent, if applicable. When the parties cannot come to an agreement as to the release of escrow, and they make conflicting demands for the funds, the escrow agent will generally not be able to release the funds to either party. An escrow agent (or broker) shouldn’t release funds unless both parties sign a release.
However, if you’re working with a seller who wants to make a claim on the escrow funds, promptly notify the escrow agent or broker to avoid inadvertent disbursement. It’s important that you communicate with your broker, the escrow agent, and the closing agent to let them know your objection to the release of an escrow deposit. Make sure you carefully follow the notice requirements of your contract.
When the parties cannot come to an agreement as to the release of escrow, and they make conflicting demands for the funds, the escrow agent will generally not be able to release the funds to either party. An escrow agent (or broker) shouldn’t release funds unless both parties sign a release.
Depending on your location, your contract may require that the parties attend mediation or arbitration before proceeding to litigation to determine entitlement to the escrow deposit. The actual remedy may vary if the escrow is being held by a broker, by a title company, or by an attorney. Assuming your contract doesn’t have a provision for mediation or arbitration—or that both steps have been completed—the escrow agent would typically file a lawsuit, known as an interpleader action, in order to be removed from the dispute. Funds are thereby deposited in the registry of a court. The amount of time that an escrow agent may be willing to wait to initiate a lawsuit will vary depending on each agent’s policies. It’s common practice for an escrow agent to hold the funds if the parties are making progress toward a resolution.
Occasionally, the deal may be disrupted at a point where the escrow agent is already holding the down payment and funds from the lender. Lenders normally require that a closing agent return the loan proceeds if the transaction doesn’t close. Likewise, the down payment tendered by the buyers is generally returned and not subject to the procedures and terms outlined in the purchase agreement for escrow funds.
When filing an interpleader action, an escrow agent is typically reimbursed from the funds in escrow for any attorney’s fees and costs incurred in the filing. This will inevitably diminish the amount of funds available to be distributed between the parties. That’s why purchase contracts—and common sense—dictate that buyers and sellers should try to come to an amicable settlement to avoid the cost and other challenges of litigation.