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Paragraph 5 of One to Four Family Residential Contract Explained

July 16, 2020
By: Stephen Etzel

One to Four Family Residential Contract: Dissecting Paragraph 5

Paragraph 5 of the TREC One to Four Family Residential Contract relates to earnest money and has been the culprit for misinterpretation and confusion among real estate professionals and consumers.

Often earnest money is confused with option fees in Paragraph 23.

What is Earnest Money?

Earnest Money is a Buyer performance agreement (not consideration) paid when agreed upon in the contract. The monies are to show that the buyer has a serious intent (e.g., good faith) to purchase the property. The funds are deposited into an escrow account within the time specified by the contract (Buyer, 3 calendar days) In addition, these funds can be used in the event Buyer defaults, as liquid damages to compensate the Seller for such breach.  Similarly, if the Seller is in default, the Buyer is entitled to return of their earnest money). Upon closing the property, the earnest money is used to go towards closing costs and/or the down payment.

Now let’s dissect Paragraph 5 sentence by sentence:

EARNEST MONEY: Within 3 days after the Effective Date, Buyer must deliver $_____________ as earnest money, as escrow agent, at____________________________________________ (address). Buyer shall deliver additional earnest money of $____________ to escrow agent within _____ days after the Effective Date of this contract.

If Buyer fails to deliver the earnest money within the time required, Seller may terminate this contract or exercise Seller’s remedies under Paragraph 15, or both, by providing notice to Buyer before Buyer delivers the earnest money. If the last day to deliver the earnest money falls on a Saturday, Sunday, or legal holiday, the time to deliver the earnest money is extended until the end of the next day that is not a Saturday, Sunday, or legal holiday. Time is of the essence for this paragraph.

1st Sentence: Within 3 days after the Effective Date, Buyer must deliver $_____________ as earnest money to______________________, as escrow agent, at _______________________________________________ (address).”

As stated in the earnest money definition above, this is a Buyer performance agreement with no consideration in relation to a TREC form which means earnest money is not the required consideration to make the contract. However, other consideration (quid pro quo or this for that) is required.

For example, Paragraph 1 (parties) is considered consideration, a promise exchange for a promise. A performance is negotiated between the parties and not required as one of the six elements (offer and acceptance, mutual consent, legal purpose, consideration, competent parties, define terms) that are typical to create a valid contract.

“Within 3 days” relates to calendar days except for Saturday, Sunday, and legal holidays. The buyer must tender funds to the named escrow agent in Paragraph 5.  “After Effective Date” is when the counting begins. This information is found on page 8 of the One to Four Family Residential Contract. The section calls for the Broker (agent) to fill in the date. Counting begins on the day after the Effective Date, so Day 1 is the calendar day following the date of execution.

EXECUTED the day of___ , 20____ (Effective Date). (BROKER: FILL IN THE DATE OF FINAL ACCEPTANCE)

2nd Sentence: Buyer shall deliver additional earnest money of $____________ to escrow agent within _____ days after the Effective Date of this contract.”

Additional earnest monies may be taken to the title company if the parties require it under the paragraph. This section can be used if the Buyer does not have the full deposit amount to deliver to the title company. An example could be: the Buyer offers $2,000 earnest money upon execution of the contract, then offers $1,000 within 10 days after payday.

Another example: the Buyer does not want to have to pay the full amount of earnest until after the option period (which is the unrestricted right to cancel a contract for any reason). The Buyer offers $500 earnest money upon execution of the contract and after the option period expires, deposits another $2,000. In most cases, the inspections are performed during this period. If the Buyer sends a repair amendment to the Seller and the parties cannot agree upon repairs, the Buyer can back out without “locking up” the $2,000 with the title company until the mutual release agreement is signed.

Paragraph 23 says:

TERMINATION OPTION: For nominal consideration, the receipt of which is hereby acknowledged by Seller, and Buyer’s agreement to pay Seller $_________ (Option Fee) within 3 days after the Effective Date of this contract, Seller grants Buyer the unrestricted right to terminate this contract by giving notice of termination to Seller within_____ days after the Effective Date of this contract (Option Period).

3rd Sentence: If Buyer fails to deliver the earnest money within the time required, Seller may terminate this contract or exercise Seller’s remedies under Paragraph 15, or both, by providing notice to Buyer before Buyer delivers the earnest money.”

If Buyer fails to deliver the earnest money within the time required, Seller may terminate this contract or exercise Seller’s remedies under Paragraph 15, or both, by providing notice to Buyer before Buyer delivers the earnest money.

The third part of the section provides that the seller can consider it a default of the contract if the earnest monies are not delivered by the Buyer within the stipulated time. It refers to paragraph 15. If the seller chooses to terminate the contract, they must use the Seller’s termination form (contracts do not die, they terminate). Moreover, if the buyer delivers the earnest monies after the 3 days, and the Seller did not exercise their right during the allotted time frame, the Seller waives their legal right to consider it a default.

Paragraph 15 says:

DEFAULT: If Buyer fails to comply with this contract, Buyer will be in default, and Seller may (a) enforce specific performance, seek such other relief as may be provided by law, or both, or (b) terminate this contract and receive the earnest money as liquidated damages, thereby releasing both parties from this contract. If Seller fails to comply with this contract, Seller will be in default, and Buyer may (a) enforce specific performance, seek such other relief as may be provided by law, or both, or (b) terminate this contract and receive the earnest money, thereby releasing both parties from this contract.

4th Sentence: “If the last day to deliver the earnest money falls on a Saturday, Sunday, or legal holiday, the time to deliver the earnest money is extended until the end of the next day that is not a Saturday, Sunday, or legal holiday.”

If the last day to deliver the earnest money falls on a Saturday, Sunday, or legal holiday, the time to deliver the earnest money is extended until the end of the next day that is not a Saturday, Sunday, or legal holiday.  It is important, therefore, that you get a receipted copy of the contract reflecting the date the earnest money was tendered/received by the escrow agent.

5th Sentence: “Time is of the essence for this paragraph.”

The meaning “time is of the essence” in the contract means that the performance by one party or within the time specified in the contract is necessary for the other party to require performance by the other party. Another definition is “the punctual completion of the task as a vital element of the performance of the contract.” Any failure to complete the task may (meaning not absolutely) constitute a breach of the contract. For example, if the Buyer does not deliver the earnest monies within the three-day time frame, the Seller may terminate the contract or continue forward.

Option Fees, on the other hand, are payment for the unrestricted right to terminate the contract within the specified time frame.  DO NOT TENDER PAYMENT FOR OPTIONS FEES TO THE TITLE COMPANY since this paragraph specifically states that “if Buyer fails to pay the Option Fee to Seller within the time prescribed,” that paragraph will not become a part of the contract and “Buyer shall not have the unrestricted right to terminate” the contract.  Page 10 of the contract has a separate receipt for the Option Fee which can only be signed by the Seller or the Listing Broker.  While it may be convenient to give both the Earnest Money and Option Fee to the title company, it is not legally sound.

We hope this article explaining the meanings of the different sentences in Paragraph 5 in TREC’s One to Four Family Residential Contract is helpful. If you have any further questions, please contact the author, Stephen Etzel, at etzelpc@aol.com.

This is intended for reference only, and should not be considered a substitute for legal or title underwriter advice that is based on specific facts of a transaction.

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ABOUT THE AUTHOR:

Stephen Etzel

Stephen Etzel
Owner of Stephen Etzel Consulting

For over 22 years, he has helped clients in the real estate industry with continuing their education and enhancing their businesses. Teaching is his passion, which is why he enjoys assisting agents and brokers with learning new subjects. He also loves sharing ideas and knowledge to help businesses thrive.

Certifications: GRI, SRES, ABR, CDEI

 

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