Suppose you are buying some property. You enter into a contract and give the earnest money deposit to the escrow agent. Before you close, the escrow agent goes broke, and the earnest money is gone. Who bears the loss—you or the seller? Clearly, neither one is at fault.

The answer: In most cases, you, the buyer, are at fault. Here’s why:

The general rule is that when money is placed in escrow, the risk of loss is on the party who would be entitled to the money if the escrow were terminated at the time the money disappeared. In the case of the sale of property, the courts have generally held that the buyer is entitled to the money, and therefore must bear the risk of loss, until everything has happened that must happen for the closing to occur.

This means that the entire down payment must have been deposited, all necessary documents must have been placed in escrow, and sometimes even that the deed shall have been placed in escrow, and sometimes even the deed shall have been recorded. In other words, until the closing occurs or at least is ready to occur, the seller is not entitled to the money and the buyer bears the risk of loss. The theory is that until the escrow is completely ready to close, it is still the buyer's money, so it is his loss if it disappears. If he still wants to purchase the property (or avoid a lawsuit by the seller), he will have to come up with the money a second time to close.

There are a couple of exceptions, however. First, the parties can agree in the escrow instructions who will bear the risk of loss. As a practical matter, this is rarely done, because the parties usually are not thinking the possibility of a loss when opening an escrow.

Second, if the escrow holder is the agent of a particular party, rather than being an independent stakeholder, that party will bear the risk of loss. For example, if someone hires a broker to sell his property, the seller is responsible for the loss of the earnest money deposit if the broker absconds with it, because the broker was the seller's agent, not an independent stakeholder.

The Lessons
The first lesson is to select a substantial, reputable institutional escrow agent, such as a major title company or bank, in order to minimize the possibility of bankruptcy or fraud. In most cases, you should avoid having a broker or other individual hold the funds.

The second lesson is to avoid having your own agent, such as a broker you have hired, hold the funds, even for a short period of time, because if they disappear it is usually your responsibility.

The third lesson, especially if you are the buyer, is to keep the earnest money deposit to a minimum and do not leave large sums of money in escrow any longer than necessary.

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