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Battles Over Real Estate Escrow Deposits

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The decline of our economy is causing many homebuyers and landowners to second-guess their decisions before closing on real estate transactions. Buyers and sellers have been forced to weigh the consequences of walking away from deals and, in many circumstances, escrow deposits.

When a property's value declines drastically prior to the closing of escrow, the loss of an escrow deposit may be a calculated risk that buyers and sellers are willing to accept. A thorough understanding of the escrow process and the documents that govern the transaction can save the parties considerable expense and reduce the risk of litigation. A well-worded purchase and/or escrow agreement may protect a buyer from losing his escrow deposit or protect a seller from going uncompensated for having tied up the property from other prospective sales during the escrow period.

Escrow Basics

Escrow is generally a deposit of funds by one party for delivery to another party upon completion of a particular condition or event. Whether you are the buyer, seller, lender, or borrower, you want to be sure that no escrow funds or property changes hands until all of the instructions and contingencies in the contract have been satisfied. The parties to the escrow enter into written instructions and deliver them to the escrow officer who processes the escrow account according to the instructions. When all requirements are met, the escrow will be "closed" and the funds disbursed according to the instructions. Each escrow is tailored to the specific property and transaction.

When Financing Is a Problem

In a real estate transaction, both the buyer and seller have certain rights and obligations. Both parties agree to the terms that define the transaction. These terms include sales price, time frame for closing escrow and various contingencies that must be removed before the transaction is settled. Perhaps the most significant contingency in a real estate transaction is financing.

Most lenders require the property to appraise in close relation to the sales price. In the ever-softening real estate market and tightening credit market, many properties are coming up short on appraisals, leaving the parties in difficult positions. Buyers are faced with higher down payments and sellers with the need to lower prices. Too often, neither party will compromise. This leads to canceled purchase agreements.

Canceling the Purchase Agreement

One might assume that a buyer's inability to secure financing would automatically be grounds for canceling the purchase agreement. This is not always true. However, just as the buyer has the right to purchase the property for the agreed-upon terms, the seller may have the right to be compensated for the property. This compensation can mean the forfeiture of part or all of the buyer's escrow deposit. The specific language of the purchase agreement and accompanying documents will govern how the escrow deposit is to be handled in the event of contract cancellation.

The escrow agreement portion of the sales contract provides specific instructions for the handling and disbursement of the escrow funds. This document or clause will also dictate the terms of forfeiture in the event of contract cancellation by either party. It is imperative that specific circumstances, such as the failure of the property to appraise at the sales price, be addressed in order to protect each party's rights.

Enforceability of Real Estate Contracts

Most states, including Arizona, require that contracts for the purchase of real estate be in writing. Even so, oral agreements are not unheard of. However, there is very little to protect a buyer or seller when dealing with an oral agreement, sometimes called a handshake or gentleman's agreement. While verbal agreements were once commonplace, given the complexity of today's real estate transactions, enforceability will almost always require a written agreement. Likewise, keeping written correspondence, including e-mail, is a good practice when dealing with real estate transactions.

Escrow Litigation

When escrow conflicts occur, litigation often follows. The escrow holder is not permitted to disburse the funds until all escrow provisions have been met. However, if the parties to a real estate transaction cannot agree on the disbursement of escrow funds, a process known as interpleader can remove the escrow agent from liability by depositing the escrow funds with the local court system. A judge will then determine the proper method and means of releasing the escrow funds.

In Arizona, all contracts for the sale of real property or an interest in the property must be in writing. It is important to note that states differ in their statute of limitations (the time during which a party may sue) pertaining to escrow claims. Arizona's statute of limitations varies according to the type of contract in dispute. In Arizona, actions for specific performance for the conveyance of real property have a four-year statute of limitations; written contracts for debt have a six-year statute of limitations; and oral contracts, if proven, have a three-year statute of limitations. Contract disputes concerning real estate most often involve a demand for escrow funds or specific performance for the transfer of the property.

Protect Yourself

The weak and often tumultuous climate of today's real estate and lending markets should provoke both buyers and sellers to carefully consider the consequences of a canceled real estate transaction. Each party should ensure that it is protected - in writing - in case of unforeseen circumstances, such as low appraisals, and that the handling of the escrow deposit is clearly outlined to accommodate these circumstances. Parties might successfully avoid litigation by having their contracts drafted - or at least reviewed by qualified attorneys before signing. In the event of litigation, a party should retain a qualified attorney to help them protect their rights.

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