Real estate purchasers whose contract permits the return of the earnest money deposit if financing cannot be obtained must be extremely careful in how this contingency is worded in the purchase contract, or a purchaser may get an unwelcome surprise, and be forced to forfeit the earnest money when financing cannot be obtained.
Typically, when a purchaser needs bank financing to purchase real estate, it will make its obligation to purchase contingent upon obtaining that financing. In this type of transaction, the deal is premised upon the purchaser having the lender’s funds available at closing to apply towards the purchase price. At the same time, a real estate purchaser generally puts up some of its own money at the time of contract – as an earnest money deposit – to provide assurance to the seller of performance under the contract, and also to provide a possible fund for seller’s liquidated damages in the event of a default by purchaser. The deposit, however, is usually refundable in the event of a termination of the contract without purchaser’s fault.
So, if there is a financing contingency in a contract, and the purchaser does not obtain that financing, it follows that a termination of the contract based on the failure of that contingency would result in the return of the earnest money deposit to the purchaser. Right?
Not necessarily according to the Illinois courts. In a recent decision, Triple R Development, LLC v. Golfview Apartments I, L.P., an Illinois appellate court held that a financing contingency did not require a refund to the purchaser of the earnest money deposit when the purchaser failed to obtain the necessary financing to close. The court interpreted the contract’s financing contingency to require only a determination of the purchaser’s “eligibility” for financing – and not the obtaining of a commitment for funding or the funding itself. Because it found that the purchaser was in fact “eligible” for financing, the court held that the contingency was satisfied, even though the purchaser did not actually obtain the financing.
The Triple R Development court focused on the language of the contingency — which did not refer to financing in general – but rather to the purchaser’s “determination of eligibility” to receive certain tax credits necessary in connection with the financing. Although elsewhere in the agreement there were references to the need of the purchaser to “obtain the financing” to be able to close, the court chose not to read those provisions in combination with the specific contingency language, to create a more general financing contingency.
Accordingly, the court upheld the lower court’s determination that the contingency was satisfied, that the purchaser was in default due to its failure to consummate the transaction, and that the seller was entitled to the payment of purchaser’s earnest money deposit ($230,000) to cover its damages. The court was not persuaded by the general legal principle that forfeitures in contracts are not favored, instead focusing on the function of the earnest money deposit to assure purchaser performance, and asking rhetorically, “[w]hat is the purpose of a deposit if it is to be returned to the buyer whenever the buyer chooses not to proceed?”
This decision underscores the importance of the precise language of financing contingencies in real estate contracts, and how they must be written and understood based on the level of comfort or certainty required by the purchaser as to the ability to obtain financing – as evidenced by loan eligibility, loan commitment, loan closing, or receipt of loan proceeds. The court was not willing to interpret the contingency language beyond the loan “eligibility” language to avoid a forfeiture. The decision also reflects the tension between real estate contract financing contingencies – which are designed to give a purchaser an “out” – and earnest money deposits – which are given to protect a seller from a “walk.”