Daily Development for Tuesday, April 20, 2004
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu

ESCROWS; INSTRUCTIONS: Where escrow instructions do not compel escrow agent to deliver earnest money to seller upon buyer’s default, but simply state that agent shall hold monies “for the mutual benefit of the parties,” broker/escrow agent had no authority to release funds to seller without buyer’s consent even where it is apparent that the buyer has not closed and no contingencies remain to be satisfied, notwithstanding the fact that the contract supports seller’s claim to the earnest money as liquidated damages upon buyer’s failure to perform.

International Capital Corp. V. Moyer, 2004 WL 438976 (3/10/04) (not yet released for publication.)

Broker showed property to seller, which entered into a contract to buy. The case does not make clear what agency relationship the broker had with any of the parties. The contract provided that earnest money would be forfeited as liquidated damages should buyer fail to close. The parties agreed, upon the urging of the broker, that the broker would serve as escrow of the earnest money. The contract provided simply that the broker would hold the earnest money as escrow “for the mutual benefit of the parties.”

Over time, buyer, which was trying to put together an investment group, asked for a number of extensions, each time increasing the amount of the escrow. In letters relating to these extensions, it stated that the money in the escrow was not to be released without its consent.

Ultimately, the final extension period ran out and buyer had not closed, although it still was trying to put together its investors. Seller was tolerant of this for a while, but ultimately found another buyer and pressed the broker to release to it the earnest money, as the time for closing had long since passed and there were no contingencies to buyer’s duty to close. Broker, concluding that the seller had a right to the money under the terms of the contract, transferred the money to seller, even though broker new that buyer would object and intended that the earnest money not be transferred without its prior consent.

Buyer sued for breach of fiduciary duty, and the trial court held for the defendant broker and ordered restoration of the money to the buyer from the broker.. (Broker had an indemnification agreement from the seller.) The appeals court here affirmed that the release of the monies was wrongful, but remanded on the question of damages. As to the latter point, the court concluded that if indeed the seller was entitled to the earnest money under the contract, then the buyer suffered no damages as a consequence of the release (except possibly a small amount of interest, because ultimately a court would have order the release anyway.

The court noted that the earnest money agreement and the sale agreement are separate. Where no contract requires otherwise, the buyer is free to require that, even if in fact he owes the earnest money as liquidated damages, the court make such a determination, and not the escrow agent. That was the case here. The buyer had signed no agreement providing for the forfeiture of the earnest money, and in fact had made a point of maintaining that it objected to any such release by the escrowee/broker. The reason for this was not to resist the forfeiture so much as to keep the deal alive so that the broker could continue efforts to put together its own investment group.

The court ruled that although the escrowee acted wrongfully in releasing the funds, it would remand to the trial court for a reevaluation of the damages remedy. It noted that if indeed that seller stood to forfeit the earnest money when a court reviewed the question, then the buyer had suffered very little damages by the forfeiture. Here, it appeared that there were no excuses and the buyer really did stand to forfeit, so the court remanded for a redetermination of the damages.

Comment 1: If the broker had not released the escrow monies, there might not have been another sale. Those monies may have been critical to make the deal. The result would be that the buyer would have had a bit longer to put together its own deal, and might have succeeded. And the seller may have agreed to go along, even though it didn’t have to. So it’s not a bit clear to the editor that the damages need to be redetermined. But we don’t know enough about the other deal.

Comment 2: So the sloppy escrow agent may have dodged a bullet here. It won’t always be that easy. Most lawyers advise escrow agents caught in this pickle: “When in doubt, interplead.” You don’t need agreement to interpleader in advance to use the remedy. You just have to be a stakeholder of a disputed stake.

But the real problem here likely arose from the fact that the “pressure” brought by the seller was that the broker would lose important business relationships if he didn’t cooperate. The story is the same one that I’ve been reiterating for a few years on this list - people make big mistakes when they become escrows as accommodations to important clients. Sooner or later the clients will want favorable treatment from “their” agent. The cost of not giving that favorable treatment is loss of important business contacts. The best way to avoid paying that cost is not to get into the escrow business at all. Clients ought to be brought to understand ethical responsibilities and fiduciary duties. If they go off and find others less scrupulous, it’s a bitter pill, but that’s what we call professionalism. Personally, I don’t find it too offensive if the client later, in the country club locker room, says: “ I had to stop using X, X insists on ethics and honesty. I can’t afford that
.” Others who listen will conclude that’s exactly what they want.

Comment 3: Further, lesson 1 of escrows is “get clear instructions.” Even if the broker chose to ignore all the other lessons set forth above, it should have heeded this one.

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