Earnest Money Dispute in California: Who Keeps the Deposit if a Sale Fails

Who gets the earnest money when a California home sale falls through?

The contract decides. Your purchase agreement says when the buyer may cancel and get the deposit back, when the seller may keep it, and what happens if neither side agrees. California statutes then limit how much a seller can keep and penalize a party who blocks the release of money without a real reason.

Three questions frame a deposit fight:

• Was a contingency still open? Loan, appraisal, inspection and sale-of-home contingencies let a buyer cancel within set periods. A buyer who cancels in time and in the way the contract requires is generally entitled to the deposit back.
• Who failed to perform? A liquidated damages clause compensates the seller when the buyer fails to complete the purchase. If the seller could not deliver clear title or refused to close, that clause does not hand the seller the deposit.
• Did both sides initial a liquidated damages clause? Without one, a seller who claims the buyer defaulted has to prove actual losses instead of simply keeping the deposit.

Reread the cancellation notice that was actually sent, not the one you remember. Its date, the form used and who signed it can decide the dispute.

How does the 3 percent liquidated damages rule work?

For a home of one to four units that the buyer intends to live in, a liquidated damages clause is presumed valid only up to 3% of the purchase price (Civil Code section 1675). Liquidated damages means an amount agreed in advance as the seller's compensation if the buyer defaults.

Reasonableness looks at the circumstances when the contract was signed and at the price and terms of any resale, or contract to resell, made within six months of the buyer's default (section 1675(e)). A quick resale at a higher price is the kind of fact that can weigh against the seller.

The clause also has to meet strict formalities. Each party must separately sign or initial it, and in a printed contract it must appear in at least 10-point bold type or in contrasting red print in at least 8-point bold type (Civil Code section 1677). A later deposit counts as liquidated damages only if a separate clause covering that payment is also initialed (Civil Code section 1678). If your deposit was increased partway through escrow, check for that second set of initials.

Why won't escrow just release the deposit?

Escrow is a neutral holder that acts on instructions from both sides, so after a sale collapses it wants both signatures before money moves. If one side refuses to sign, the deposit stays put, and the escrow holder can also file an interpleader action asking a court to decide (Civil Code section 1057.3(g)).

California puts the duty on the buyer and seller, not the escrow officer. Section 1057.3(a) says both parties must make sure deposited funds go back to the person who deposited them, or to whoever the contract entitles, if the purchase does not close on the contract date or a signed extension.

Signing escrow release papers does not by itself cancel the contract or waive a breach claim unless the document says so (section 1057.3(e)). That matters if you want the deposit back and still plan to claim other losses.

The 30-day written demand under Civil Code 1057.3

If the other party fails to sign the documents escrow needs to release the funds within 30 days after your written demand, section 1057.3(b) makes them liable for the funds not held for a good faith dispute, treble damages of not less than $100 and not more than $1,000, and reasonable attorney's fees in an action to enforce the section.

Three limits apply. The liability runs to the person who made the deposit, usually the buyer. The penalty does not apply when the money is withheld to resolve a good faith dispute, meaning the withholding party reasonably believed it was legally entitled to the funds, and the person seeking the money must prove there was no such dispute. The section also covers only property with one to four residential units where the buyer intends to occupy one of them.

Put the demand in writing and keep it specific:

1. Collect the purchase agreement, every addendum, any cancellation notice and the escrow cancellation instructions.
2. Mark the close-of-escrow date and any signed extension, since the duty in section 1057.3(a) runs from the missed closing date.
3. Write to the other party (and their agent, with a copy to escrow) demanding that they sign the release within 30 days.
4. State the contract term that entitles you to the money, such as the contingency you cancelled under and the date you did it.
5. Cite Civil Code section 1057.3 and its remedies in plain terms, without threats.
6. Keep proof of delivery (certified mail with a return receipt, plus an email copy) and mark day 30 on your calendar.

Example: two deposits, two different answers

Example (hypothetical): two buyers each agree to buy an $800,000 house they plan to live in, and each sale falls apart.

These are starting points. Contract wording, notice dates and the resale price can change either result.

What an earnest money demand letter says

Keep the letter short and anchored in documents. It may be forwarded to people who never saw the file, so lead with facts a stranger can check.

A seller writing to a buyer who walked away can use the same structure: identify the default, the initialed clause and the amount, and ask the buyer to sign the release. Leave out the section 1057.3 penalty, though, because that liability runs only to the person who made the deposit. For more on structure, see the guide to writing a breach of contract demand letter.

What happens if the other side still won't sign?

If day 30 passes, the next step depends on the amount and your contract. Check whether the purchase agreement requires mediation or arbitration first, since some agreements tie attorney's fees to trying mediation before suing. Our guide to mediation before a lawsuit in California explains how that works.

• Small claims: an individual can sue for up to $12,500 (Code of Civil Procedure section 116.221), which may fit a smaller deposit. See sending a demand letter before small claims.
• Civil court: larger deposits go to superior court. Once a section 1057.3 action is filed, escrow deposits the disputed sum, less cancellation charges, with the court and is discharged (section 1057.3(d)).

If the sale failed because the seller hid a problem the inspection uncovered, the deposit may be only part of the claim. Our guide to seller nondisclosure claims covers disclosure duties.

Having an attorney write the escrow release demand

A frozen escrow deposit is a contract question with a statutory clock attached, and the 30-day demand is clearest when it names the exact contingency, notice date and clause. Having an attorney write that demand is worth considering when the deposit is large, when the other side has its own lawyer, when the liquidated damages clause or its initials are in doubt, or when you expect to argue there was no good faith dispute.

Through Talk to My Lawyer, a licensed California attorney writes your letter from your purchase agreement, cancellation notice and escrow papers, and sends it on your behalf. Whether to sue for the deposit or other losses is worth talking through with a lawyer who has read your contract.