Suppose you are buying some property.
You enter into a contract and give the earnest money deposit
to the escrow agent. Before you close, the escrow agent goes
broke, and the earnest money is gone. Who bears the loss—you
or the seller? Clearly, neither one is at fault.
The answer: In most cases, you, the buyer, are at fault.
The general rule is that when money is placed in escrow,
the risk of loss is on the party who would be entitled to
the money if the escrow were terminated at the time the money
disappeared. In the case of the sale of property, the courts
have generally held that the buyer is entitled to the money,
and therefore must bear the risk of loss, until everything
has happened that must happen for the closing to occur.
This means that the entire down payment must have been deposited,
all necessary documents must have been placed in escrow, and
sometimes even that the deed shall have been placed in escrow,
and sometimes even the deed shall have been recorded. In other
words, until the closing occurs or at least is ready to occur,
the seller is not entitled to the money and the buyer bears
the risk of loss. The theory is that until the escrow is completely
ready to close, it is still the buyer's money, so it is his
loss if it disappears. If he still wants to purchase the property
(or avoid a lawsuit by the seller), he will have to come up
with the money a second time to close.
There are a couple of exceptions, however. First, the parties
can agree in the escrow instructions who will bear the risk
of loss. As a practical matter, this is rarely done, because
the parties usually are not thinking the possibility of a
loss when opening an escrow.
Second, if the escrow holder is the agent of a particular
party, rather than being an independent stakeholder, that
party will bear the risk of loss. For example, if someone
hires a broker to sell his property, the seller is responsible
for the loss of the earnest money deposit if the broker absconds
with it, because the broker was the seller's agent, not an
The first lesson is to select a substantial, reputable institutional
escrow agent, such as a major title company or bank, in order
to minimize the possibility of bankruptcy or fraud. In most
cases, you should avoid having a broker or other individual
hold the funds.
The second lesson is to avoid having your own agent, such
as a broker you have hired, hold the funds, even for a short
period of time, because if they disappear it is usually your
The third lesson, especially if you are the buyer, is to
keep the earnest money deposit to a minimum and do not leave
large sums of money in escrow any longer than necessary.
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