We get many, many questions about this subject. The answers are found in Alabama Real Estate Commission Rule 790-X-3-.03(4) and (5.) Here is what the relevant part of the rule says with underlining for emphasis 790-X-3.-03. Deposit of Funds.

790-X-3-.03 (4)  Each qualifying broker shall promptly disburse to the appropriate party or parties any trust funds within 7 days of the consummation of the transaction for which the funds were deposited. If for any reason the transaction is not consummated, or if for any reason there is a disagreement involving to whom trust funds should be disbursed, the qualifying broker shall not disburse any trust funds except pursuant to a written agreement signed by all parties or pursuant to a court order.

790-X-3-.03 (5) This Rule shall not prohibit a broker from depositing with the appropriate court any trust funds which are the subject of disagreement among or between parties under the rules of interpleader or other lawful procedure.

First, let’s look at how this rule is applied to security deposits in property management situations. A lease or rental agreement is consummated when a tenant enters into a lease agreement or deposit agreement with the landlord or its agent.  This means the property management company is free to apply the terms of the agreement, and disburse funds received under the terms of the agreement. This includes forfeiture of the security deposit. The property management company is not required under any circumstances to get written permission from the tenant to forfeit all or part of a security deposit.

Earnest money under a sales contract is different. A sale is not consummated until it is closed. Pay careful attention to what the rule says about a sale that does not close.  The reason it does not close does not matter.  It does not matter if a financing contingency cannot be met, for example. It does not matter what the contract says. Even if the contract says the earnest money is “nonrefundable,” whatever that means, the rule controls. If the money is supposedly “nonrefundable,”  what is it doing in an escrow account?  If it is truly non-refundable, then it should be paid directly to the seller under a written, signed addendum to the contract clearly setting out the fact that the broker is relieved of responsibility for the money.

The rule says flatly that if a sale does not close, or if there is some dispute about to whom the earnest money should be disbursed, the broker shall not disburse the money without written, signed authorization from the parties to the contract. This authorization may not be contained in the original contract or addendum to it. I will repeat: It does not matter what the contract says. There must be a separate, written and signed authorization coming after it is established that that contract will not close.  Notice the rule does not require the parties to give a full release of all claims. The parties usually do want to do this so they can walk away without any further consequences.  Brokers typically encourage a full release for this reason.

When the parties just cannot agree, then the broker must continue to hold the money in the escrow account. Brokers usually do not file an interpleader action, because that requires a lawsuit with court costs and attorney’s fees. Some contracts provide that the earnest money can be used to pay these expenses right out of the earnest money in the event an interpleader action is filed. Perhaps the best remedy is for one party to file a civil action against the other for the money. Small claims courts are appropriate, provided the amount in dispute does not exceed $3,000. When a judge enters an order deciding the question, the rule allows the broker to disburse the money to the prevailing party. Another possible remedy lies with the State Treasurer’s office. In some circumstances a broker might be able to pay the money over to the State Treasurer’s office as unclaimed property, provided three years have lapsed since the apparent owner last communicated to the broker an interest in the money. The State Treasurer’s Web site has information regarding unclaimed property that is easy to access.

If you are waiting for an exception to the rule, there is one. It concerns foreclosed upon sellers. Here is the scenario. The seller (owner) has entered into a contract that is waiting to be closed. During this time the seller is foreclosed upon, and the sale does not close. In this case it is not necessary to get authorization from the seller to disburse the earnest money to the buyer. The law in Alabama is that a foreclosed upon owner of property is essentially stripped of all interest in the property, except the owner’s right to redeem the property within one year.  This is commonly referred to as the statutory right of redemption. Since this is the only right remaining, the seller’s signature on a disbursement authorization is worthless. Our rule does not supersede the law in this instance, nor does it require that a worthless signature be obtained.

It is important to understand that this rule governs what a broker can and cannot do. The language of the contract is very important to establish the rights and responsibilities of the buyer and seller. The parties themselves and the courts will look to the contract to ultimately decide who is entitled to earnest money when a contract does not close. Our rule just prevents the broker from being the one who makes the decision. Some other states have similar rules, while some do not. The reason for the rule is simple. It protects both the buyer and seller from arbitrary disbursements by brokers. Judges struggle with many contract issues that come before them in court. Brokers have no business deciding on their own who is entitled to earnest money.

Again, it should be noted that the information presented in the preceding article relates ONLY to people buying & selling houses in the state of ALABAMA and their agents.