By: Michael N. Russo Jr., Esquire

This article was originally published in the D.C. Land Title Association Newsletter; Volume 2, Issue 2. Reposted with permission.

Settlement companies frequently accept earnest money deposits (EMD) into their escrow accounts in preparation for settlement. This routine task can present hidden complications if not managed carefully.

Consider a scenario where the settlement company receives a contract on July 1st with a $20,000 EMD for a settlement scheduled for August 15th. The EMD is provided via two checks: one for $17,500 and another for $2,500. The $2,500 check bounces, but the buyer, who selected the settlement agent, assures that they will rectify the issue.

On August 12th, the buyers deposit their “Cash from Buyer” of $50,000. On the morning of August 15th, the lender funds its $450,000 loan amount. For various reasons, the transaction falls through irretrievably. The buyer demands their $70,000 back, and the lender wants its $450,000. The seller, however, lays claim to ALL funds in the settlement agent’s escrow, totaling $520,000. The seller contends that the escrow agreement in the contract covers all money held by the settlement agent. What must the agent do? Will the agent be drawn into the dispute between the buyer and seller and the resulting litigation? Not if the agent is well-prepared and understands their obligations.

Settlement agents act as fiduciaries for the buyer, seller and lender, with a duty to exercise the utmost care and adhere to legal obligations. The escrow agreement in the contract of sale typically serves as the “instruction” to the escrow agent. However, this provision is often insufficient.

In our example, the first issue is the settlement agent’s responsibility regarding the bounced check. The “business decision” might be to allow the buyer some leeway to reach the settlement table – this is a mistake. The escrow agent must report this adverse status to all parties involved. The report should be in writing to both the buyer and seller, seeking joint instruction on how to proceed. Remember, as the escrow agent, you are merely holding the money; you have no discretion over its handling. DC Courts have indicated that the settlement agent may also have a duty to report title problems that the agent “knew or should have known.” Therefore, it is crucial to keep all interested parties equally informed of any issues with the escrow proceeds and the transaction.

The second issue is how to respond to the conflicting demands of the buyer and seller. The straightforward answer regarding the EMD is to do nothing without joint instruction. The more complex question is whether the “buyer’s cash to close” funds are part of the escrow. Most form contracts attempt to distinguish between EMD and “cash to close,” but this distinction is often vague. It is advantageous for the escrow holder to ensure that the parties agree that the three sources of funds it holds – EMD, cash to close, and loan funds – are distinct and that only the EMD is subject to the joint instruction requirement. It should be clear that the “cash to close” and loan proceeds remain the buyer’s property until the deal is finalized. The best practice is for the settlement agent to draft and require a supplemental escrow agreement clarifying this issue for the parties.

Once it becomes apparent that there will be no quick resolution between the buyer and seller, the escrow agent must consider their options. The first step is to inform both parties that the only option is to await joint instruction or a court order. The escrow agent must not and cannot act as a mediator or judge. This position should be communicated to the buyer and seller as soon as a dispute becomes evident.

The escrow agent must then determine how long to hold the funds in the escrow account. If the parties agree, this can be any term they agree to and which the escrow holder deems appropriate. When it appears that there will be no quick solution, the escrow agent should pay the money into the court through an interpleader action. This action asks the court to accept the money, minus a fee for the escrow agent’s costs, and designate the buyer and seller as opposing parties to present their claims for a final resolution. If the parties beat the escrow agent to court, the agent can intervene in that action and seek the same relief. The interpleader action can also include an order dismissing the escrow agent from further proceedings and prohibiting either party from suing the escrow agent. No money should be released to the parties until the court’s order is final.

There are instances where the dispute over the EMD is not a “hot battle” but rather “cold.” Despite a settlement company’s best efforts, escrow money can become “orphaned funds” when buyers and sellers move forward without instructing the escrow agent. In these cases, the funds are considered “abandoned” if, after “reasonable efforts,” the buyer and seller cannot be located. In the District of Columbia, orphaned funds are considered abandoned after three years. The District of Columbia has established the “Unclaimed Property Unit” to handle such cases. Neighboring jurisdictions have similar laws and procedures for orphaned funds.

The bottom line is that the escrow process is increasingly becoming a critical function for settlement agents. While this process may not be profitable, it must be diligently managed to avoid future difficulties.

Citations: D.C. Code § 28:7-603 (covers conflicting claims and interpleader), D.C. Courts Rule 22 (covers interpleader), Federal Rule of Civil Procedure 22 (covers interpleader).

Mike Russo is a past president of the DCLTA and has practiced real estate and title law and litigation in the District of Columbia, Maryland, Virginia and New York for over 30 years. He recently transitioned his practice to a new law firm, McKenna Russo (www.McKennaRusso.com), where he represents buyers, sellers, title agents and title insurers. He can be reached at Russo@McKennaRusso.com.