Earnest Money on New Construction not Unreasonable Damages

  Question: We entered into a contract to purchase a new home in a subdivision in the Buckeye area for $300,000. We deposited $30,000 earnest money in escrow. After 45 days while the home was still in the framing stage, my wife decided that she wanted to quit her job and return to school. We will not be able to afford this new home now, and we would like the return of our $30,000 earnest money. Due to strong demand in our subdivision, the homebuilder has just raised the base price of our model home, and should therefore make a large profit when the home is built and sold to a new buyer. Is the homebuilder entitled to keep our $30,000 earnest money, even if the homebuilder is going to make a larger profit on our home because we canceled the purchase contract?  I was also told that the maximum amount of earnest money a homebuilder could keep was $2,500 if the contract was canceled. Is that true?

Answer: The theory behind earnest money is that, because damages would be difficult to determine if the buyer defaults under a purchase contract to buy a home, the seller and buyer can agree at the time of the signing of the purchase contract on a reasonable amount of earnest money that will be forfeited as damages if the buyer defaults. These damages are called liquidated damages.  Liquidated damages will not change if the market value of the home increases or decreases during the escrow/construction period.  However, if the amount of the earnest money is so disproportionate to the price of the home, e.g., $60,000 earnest money for the purchase of a $100,000 house, a court would probably not enforce the forfeiture of this $60,000 earnest money (60% of the purchase price) because the forfeiture of this $60,000 earnest money would be a penalty, and not reasonable liquidated damages.

In your situation, even if you could show that your homebuilder would make a profit now on the sale of your home when your home is completed, the homebuilder is probably still entitled to retain your $30,000 earnest money (10% of the purchase price) as liquidated damages for your default under the purchase contract for a $300,000 home.

Finally, there is no Arizona law limiting the forfeiture of earnest money to $2,500 or any other amount. In fact, buyers have forfeited earnest money of more than $100,000 in the purchase of multi-million dollar homes. Bottom line: If a buyer gives earnest money, the buyer should be “earnest” about buying the home.